Building a Better Budget

What do budgets and diets have in common?  If you adhere to a diet, in general you’ll become healthier physically and if you adhere to a budget, you’ll become healthier financially.  However, if a diet is too intrusive, most people will give it up after a short while.  Likewise, if making budgets becomes too much of a hassle, you’ll stop making them.

When I graduated pharmacy school in 2011, I came out with a mountain of debt.  Between student loans and credit cards, I owed over $160,000 for the education and lifestyle I led the 6 years before.  Just for good measure, I decided to pile on an additional $32,000 by fully financing a new car 2 years later.  All in all, my monthly debt service was costing me the escrow on a good house at that time.  But, mine isn’t a story of getting in over my head and screwing up my life through debt the likes of which you may see elsewhere.  I had a good job and statistically, I was pretty average in terms of debt for someone in my income bracket.  So if you’re looking for a story about someone who turned around their life radically against all odds, you’re not going to find it here.  Shortly after buying the five-figure toy mentioned above, I met the woman I’d eventually marry.  She didn’t much care for the car and had a very different attitude than I did when it came to money.  For her, the financial security provided by having a savings was incredibly important.  While I, like most people, knew saving money was important, I, like most people, didn’t really put much effort into bolstering my savings.  As we got further into our relationship, it became obvious that the debts I’d built up over the years made her a little uneasy.  So I had a dilemma.  I was in love with a girl that I was fast realizing I wanted to spend the rest of my life with.  But, I felt like I needed to get my house in order,  lest I screw up hers.  So as an act of good faith, I decided that I needed to at least get rid of my credit card debt to show her that I could be responsible with our money.

So how do you tackle a boat load of credit card debt?  The simple answer is to budget and pay the bill with your excess.  But what does it mean to budget?  By definition, it means an estimate of income and expenditure for a set period of time.  Put into practice, one who budgets will categorize expenses and set a limit for how much will be spent in those categories with respect to income, typically on a monthly basis.  It will then look something like this:

January 2018

Income: $2000

Expenses: $1800

  • Rent: $1000
  • Utilities: $100
  • Cable: $100
  • Food: $300
  • Clothes: $100
  • Entertainment: $50
  • Phone: $50
  • Gas: $100

Total: +$200

Now this is all fine and good.  But there are a few problems.

  1. Most, if not all, of the values in this equation are variable.  In a given month, you may make more or less money than you originally thought.  With the exception of rent and cable, all of the other categories are inherently variable based off your consumption.
  2. Because of number 1, you’re forced to reconcile every month.  Only then can you know how much of a surplus/deficit you have.
  3. Because of number 2, you can only divert funds towards debt/savings once per month.  This is inefficient given the fact that debt can be paid down quicker when making more frequent payments and investing can be less risky though the process of dollar cost averaging (more frequent investments limit the effect of fluctuations in stock prices over time).
  4. The above is a really simplistic version of a budget.  In reality, budgets call for many more line items.
  5. You have to do this whole process every month, which sucks.

Unless you really nerd out to crunching numbers (nothing wrong with that), most people won’t find maintaining a monthly budget enjoyable.  There’s a lot of work involved in making them and you have to maintain a conscious awareness of your spending across the various categories with every purchase you make.  If it sounds a lot like rigorous dieting, that’s because it is.  As someone with a consistent income, I figured that I didn’t need to live month to month and there had to be a better way.

So I consulted the Internet, in all of its wisdom for an alternative.  Turns out, there’s not really much else out there.  Budgets and how to do them, haven’t really changed much over the years.  Sure there are tools that make tracking your purchases easier, but nothing that really address the efficiency issue or the fact that I need to keep tabs on many different types of purchases.

Inspiration comes from odd sources sometimes.  As a retail pharmacist,  one of the major themes in my industry is medication adherence.  Adherence drives everything from prescription fill counts to insurance reimbursement rates.  Now, there are a few main factors that drive medication adherence.  Some, like medication tolerability (severity of side effects), cost, patient disability, etc.  are out of my control.  However, automating medication refills, which has been shown to dramatically improve patient adherence, is something I can affect.  By automating medication refills, we can encourage a patient’s adherence by taking forgetfulness and procrastination out of the equation.  Through this increase in adherence, favorable outcomes such as decreased hospitalization and death, are realized.  I had been relatively successful in my own practice at implementing these types of programs and by extension, they helped ease my workload since I became more proactive about my work rather than reactive.  Seeing the benefits of automating this workload firsthand, I started wondering if there were any ways I could incorporate the benefits of automation into the rest of my life.  I began to think, how can I automate my finances to improve my own outcomes?  Can I develop a program to put my money on auto-pilot?

To start, I needed to figure out what I wanted from this program.  Four basic traits came to mind:

  1. Be easy to use
  2. Be efficient
  3. Be instructive
  4. Be engaging

First, in order to be easy to use, I needed to make sure that I wasn’t having to make a new spreadsheet every month.  Looking at my expenses, it was clear that some expenses were monthly while others happened once a year (or even every couple years).  With that in mind, it made sense to structure the budget on a yearly basis.  Doing this would at the very least, cut down on the amount of spreadsheets.

Second, it needed to be efficient.  In this case, efficiency represented creating a scenario where I could divert money towards my goals as soon as it came in.  Since I got paid on a consistent basis, being able to incorporate my pay schedule was a must.

Third, I needed my budget to tell me if I had any extra money to play around with.  And if I did, I needed that information to come constantly so that I could make financial decisions efficiently.  To do that, I needed to be able to reconcile money in with money out as frequently as possible.  Enter SIMPLE MATH!  Treating each paycheck as a component of yearly earnings would allow me to extrapolate the effect my yearly expenses have every time I got paid.

Lastly, I wanted the budget to be engaging.  By that, I wanted it to prompt me to take action on a regular basis.  By informing me that I had extra money with each paycheck, it would prompt me to do something with that money.  Since that money was earmarked for my financial goals, I would be less likely to squander it and instead use it to pay myself first

Putting it all together, I made spreadsheet!  The first thing I needed to do was take a full inventory of recurring expenses and my income.  Once those values were in, I got a percentage telling me what portion of my income was going towards bills.  Great!  But what do I do with that information?

At the time, all of the money from my paycheck was going into a single checking account.  All of the money I had coming in was co-mingled with the money I used to pay bills, pay for day to day expenses, and possibly divert to savings.  Since the roles each dollar I had in that account were ambiguous, It created a situation that not only kept me from saving more, but made the risk of over drafting the account much higher.  So with this in mind, I asked why just have one checking account?  Why not have money for your fixed expenses in one account, and those for your variable ones in another?  So I opened another account to split up the expenses (which was really easy by the way), and used the percentage provided by the spreadsheet to tell my payroll department how to split the money coming out of my paycheck into the accounts.

So now, we had my bills on auto-pilot.  Money coming into the account was replenishing the money coming out.  I needed to make sure I had a bit of a buffer in that account since money coming out wasn’t consistent all throughout the month, but overall, it worked.  I also was able to see how much money I had to play around with which led to the next question, how much can I put towards my other goals?  This part can be tricky.  You do have necessary expenses going into the non-bills account such as food, clothing, and fuel.  But you also have lifestyle expenses such as entertainment, shopping, dining out, or travel.  This is where a little bit of traditional budgeting comes into play.  Since your necessary expenses will be relatively consistent, you should be able to track them and get a rough idea of how much money will go towards needs.  The rest of the money going into that account just fuels your lifestyle.  With that in mind, that lifestyle money is where I looked first to find my savings.

Turns out, I spent a lot of money on BS.  I literally spent thousands of dollars on high end craft beer.  Things like that were easy to cut out.  I also spent a lot of money on video games and other types of entertainment.  Didn’t want to cut that out entirely but I certainly needed to spend less.  Long story short, there was money to save here and much of it was pretty obvious.  That’s all well and good, but how could I incorporate that savings into my idea of automating my finances?

Putting it all together, my finances looked something like this at the time:

Bills: 67%

Daily Expenses: 18%

Savings Opportunity: 15%

With this knowledge in hand, I knew that this was where I was going to get the money to pay off the credit card.  I also, thought it would be a good idea to start having a savings so that I wouldn’t need to use the card in the future.  With these goals in mind, I opened a savings account and called up my payroll department again.  This time, I added a small percentage going to a savings account and adjusted the amount going into my bills account so which that savings out of my general slush fund.

In all, I now had a budget system that told me exactly how much I could safely put towards my financial goals with every paycheck.  What’s more, once the initial work was done, I only had to revisit the budget whenever my income or recurring bills changed.  In the years that followed, it allowed me to not only get rid of credit card debt quickly but allowed me to build net worth efficiently and consistently.





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