Tuesday, June 16, 2009

Kevin's Simple Budgeting Technique

I had a recent conversation with a friend and was surprised to find out that he had credit card debt. Doing a quick poll I’ve realized that many of us do. It kind of just sneaks up on us. There are two solutions here. Destroy your credit card or come up with a budget. If you have a high amount of credit card debt (roughly ¼ of your yearly salary or more) I would consider the former. If you have a little debt that you can never seem to pay down then try Kevin’s patented budgeting technique.
Drastic changes don’t work in diets and don’t work in budgets. You need to be able to make permanent changes. So that means you still need the budgetary freedom to do the things you enjoy. Start small and work your way up. Don't try to hit it out of the park from the get go.

1. Allocate a certain amount of money for your favorite hobbies/passion
Right now I really enjoy rock climbing, crossfit, and going out to eat about 1 time a week. These are hobbies right now that I am passionate about doing. Rock climbing costs me 45 a month and crossfit is 135 a month. That isn’t cheap and a few of you have a lot cheaper alternatives, but I have made these activities a priority in my life and therefore choose to spend my excess cash on them. I therefore allocate the money to do these activities.

2. Add in your monthly bills
My bills are as follows: rent, insurance (1 payment every 6 months), cellphone, gas, etc. These are bills that I have to pay every month whether I want to or not. I need to put this on my budget next, because I have to pay these costs to remain debt free. Obviously some of the bills cellphone, cable, etc. could be classified into other stuff. If your budget doesn’t work then consider downsizing these costs.

3. Savings/ 401k
You need to be saving something (ideally 10-25%). Think about all the additional responsibilities you will have in the future (kids, house payment, etc.). As I stated in my previous post each dollar you save now is worth almost 2 dollars of savings 10 years from now. START NOW

4. Other stuff
This is anything else that doesn’t fit into any of the categories above. This is your discretionary spending. This money you can use on whatever you want and includes anything that isn’t a monthly bill or a passion.

A lot of people like me utilize this method and stay out of debt. Here are a few examples listed below:

Case Study 1
I knew a girl in college that only wore designer clothes. D&G, Gucci, Marc Jacobs, etc. She had it all. This girl must be burning through credit cards like money ain’t a thing I remember thinking. Then I went over to her place. She drove an early 90’s camero that had seen better days. She lived in a tiny one bedroom apartment and lived off of canned vegetables and beans. She rarely bought drinks when she went out and ate out only on special occasions. Her passion/hobby is nice clothes and so she sacrifices in other areas that are less important to her in order to get the things she wants.

Case Study 2
Another friend, absolutely loves having a nice car. He spends a lot of money on his vehicle and keeps it immaculate. To counteract that he lives with roomates, rarely goes out, and tends to wear tshirts. It doesn’t really matter to him because he loves his car and wants to spend his money on that. He’ll probably get a new car in 5 years or so, but he will have saved up enough and have good enough credit to have a very low interest rate loan. Aside from a very manageable small car payment he drives around debt free.

Case Study 3
A coworker loves to travel. In fact, if she could do anything she would travel the world and give tours. She wants a lot of discretionary income to spend on traveling; so she lives with her mom and uses the money she would have used on rent to travel the world. She’s spent more on vacation and gone more places than most of her peers. She has already been on two or three trips this year and has another one coming up in August. She thinks the travel is well worth the cost of living at home.

Each of the people above like me have very different hobbies. They all make sacrifices in areas they find less important and don’t miss so they can spend more money on things they enjoy. Try taking this approach when you budget and you will be surprised how much of your “other costs” you can eliminate without missing them.

If it’s still not working for you then you may want to try the “envelope method” which is using cash only and placing in envelopes the amount you are supposed to spend on each area and not spending more than what's in the envelope. You need to get this taken care of now so you are not trapped by your debt. You have lots of time at this age in your life and if you start good habits now then you save yourself a lot of stress in the future.

By building backwards and starting with hobbies, it actually makes the budgeting process more enjoyable. If you haven’t been able to stick to budgets in the past then give this a try. If you have any questions or want to discuss a particular issue feel free to contact me. If you want an article on a specific issue of finance let me know as well.

EDIT: My friend Nick linked me to a great article. Now is a great time to settle debt. Call your credit card company and request a reduction in your balance.

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