Let me tell you something you already know. Budgeting sucks. It's so boring. It's so time-consuming. It's so tedious. Worst of all, it doesn't even help most of us because we give up on it.
It's not our fault. Nobody wants to track every dollar, categorize every transaction into a different category and set category limits, only use cash, or carry around envelopes. What we want to do is make smart decisions with our money. While most of us know we need to do it, getting ourselves to do it can be troubling.
Don't get me wrong - for some people these techniques work very well. For others it's necessary. I'm not talking to those people today. Today I'm talking about the masses.
Psychological Trick: Framing
There's a psychological trick that gets us all the time. It's called framing. Framing something one way or another impacts our behavior. For example, a company that advertises that their product works 90% of the time will have better results than telling us their product fails 10% of the time, even though those are exactly the same thing. Knowing that our meat is 80% lean makes us feel better than knowing it's 20% fat.
Instead of falling for the framing effect we can use it to our benefit. Instead of calling it "budgeting," let's call it a "spending plan" or a "savings plan." After all, that's what budgeting is; a plan to save and spend.
You should carefully consider both spending and saving as part of your overall financial health, but you don't have to tackle it all at once.
Step 1: Savings Plan
Instead of tracking where all our money goes and then hopelessly trying to deprive ourselves, let's figure out what we need to save first. Our savings habits have a far greater impact on our future wealth than the return we get on our investments. Figure out how much you can afford to save and how much you need to save into your various savings and investment accounts (savings account, retirement account, college savings, emergency fund, etc.). Once you do that - automate!
Fewer Decisions To Make
Studies have shown that we have a limited supply of will power, and if we use it up on one task then it's not there for the next. This is where automation helps. You can automate your savings in a number of ways. First you can have money put automatically into your retirement account, and sometimes a Health Savings Account, at work. This happens before it even hits your paycheck so it's very easy. Another way is to change your direct deposit so that some money gets put into a savings account while the rest goes into your checking account. Another way is to set up automatic transfers from your checking or savings into other accounts, like investment accounts, education accounts, and so on.
By doing this you don't have to go move the money yourself. You have one less decision to make.
Spend What's Left Over
The the main driver of the financial health of future you is your savings, a case can be made that the rest can be spent...any way you like. After the savings is taken care of you don't have to worry about budgeting.
Step 2: Spending Plan
Step 1 will help you a great deal. Getting a savings plan gets you in the habit of saving a portion of your income, or paying yourself first as the saying goes. This helps future you. But what about current you?
This is where a spending plan comes in. You have to get clear about what is important to you. You have to almost be even more clear about what's not important to you. Then take a look at your spending and try to find mismatches between what you say is important to you and how you are spending your money.
A common misalignment is trying to keep up with the proverbial Jones'. If your friends, family, peers, or neighbors spend money is a certain way, it's natural for us to want to fit in. It's even easier to fall into this trap if we don't monitor whether we are spending our money appropriately. If you drive a European car as do all your coworkers, did you make that purchase because you value foreign cars? Or, did you make that purchase because you somehow felt you needed to in order to fit in? Either answer is fine, but by knowing whether you are in the second camp or not means you can start taking steps to reduce the misalignment.
Once you have both a good savings plan and spending plan you can move on to the more advanced stages. The next step is to increase your savings rate. You can do this in many ways. This could happen naturally by cutting out the spending on things you don't value. Another way is to save raises and bonuses. You may find you can satisfy your values in less expensive ways - such as getting together with friends at home instead of at a restaurant.
These are just a couple examples. The point I'm trying to make is that by automating our savings and being mindful of how we spend our money, we don't have to necessarily track every penny or use only cash. We can align our lives and our use of money and over time achieve greater financial health.
I need to address survival money. For some of us, our incomes don't cover our living expenses. To make up the difference we end up using credit cards or other forms of debt. If this is the case it's not as easy as automating savings, because there isn't enough income to save. In this case we have to get clear about how much money we need to survive (housing, transportation, food, etc.), and figure if our income can cover these basic needs. If not, we have to try to find ways to reduce those expenses or try to find ways to increase our incomes. Some of the techniques above can be very helpful (tracking, cash, envelopes) for this.
The bottom line is that we have to be clear about what's important to us and align our use of money and energy in ways that support that.
Jonathan Clements: How to Think About Money
Daniel Kahneman: Thinking Fast and Slow
Jane Bryant Quinn: Smart and Simple Financial Strategies for Busy People
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