When I started getting more serious about my finances though, I wanted to get a better understanding of my expenditures and how they were impacting my long-term savings and accumulation of capital. Getting to a place of financial independence became more important as I looked towards new chapters down the road.
But I wanted to approach the act of managing expenses in a less anxiety-provoking way that didn’t significantly alter my current lifestyle. What I needed was a financial wellness plan.
Financial Crash Diet vs. Wellness Plan
The decision to start budgeting doesn’t usually occur in a vacuum. Maybe you feel the need to cut back due to a life event or change in income. Or perhaps you are looking to boost your savings for future goals down the road.
Jumping in cold turkey though can put a serious damper on your quality of life if you don’t have the right tools to bridge the gaps. If you typically spend $800 a month on food and decide to cut back to a $500 budget without a clear strategy in mind, your attempts towards saving more money will likely take a toll on your mental health along the way.
Instead, your goals should be to:
To do this, you’ll need to establish a baseline and begin collecting some data. Since we have a few more months to go until the end of the year, this is a great time start and get into gear for 2021.
Ditch the Monthly Budget
It’s time to ditch the “B” word now and create a spending plan instead. A spending plan helps map out future income and expenditures based on your current cash flows and spending habits/obligations so that you can strategize and adapt to any necessary adjustments over time. It is an iterative process that allows you to make incremental changes and develop long-lasting habits.
I like to look at my financial picture annually because we all have different needs and routines throughout the year. Unless you are a robot, chances are there are some natural variations to your monthly spending habits. You may spend more during the holidays and spend less during the first few months of the year. Or if you live in Texas like me, you may find yourself with a whopping AC bill in the summer after 24 straight days of 100 degree weather.
Using the same monthly thresholds from traditional budgeting methods can quickly lose its value when the natural ebb and flow of expenditures cannot easily be accounted for. Instead, you want to create a framework that provides more time and space to tune into both your short and longer-term habits and identify changes that can be applied during different time frames.
If an annual plan feels too broad, opt for a semi-annual or quarterly plan instead.
How to Reverse Engineer an Annual Spending Plan
Now let’s get down to the nitty-gritty details of creating an annual spending plan. I've outlined what I've done consistently over the past two years to keep track of my income and expenses and forecast my future earnings and spend.
For the first few months, you will be establishing your baseline by gathering data on your current income and expenses. You want to get a clear picture of what your life looks like now before attempting to make any changes.
To help you get organized, I’ve shared the following Google spreadsheet that I use to log my monthly cash flows and expenses.
Make sure to download the file or make a copy first.
During the first few months, start with the following:
Since you will need to keep track of your transactions to calculate your monthly expenses, I also recommend using an online resource that captures and aggregate transaction-level data in real-time. My favorite tools are Mint and Personal Capital.
I particularly like Mint’s features around spending categories as well, which you can begin to dig into when you start brainstorming potential changes to your current expense habits. They offer some great graphical representations that quickly show your spending habits over time. See a sample screenshot of their "Trends" report below.
Sample screenshot of my favorite feature in Mint, the "Trends" report. You can view all of your expenses in one place, broken down by category.
Below are steps on how to begin this process:
1. List out all of your estimated discretionary & non-discretionary expenses
First off, list out all of your estimated regular discretionary and non-discretionary expenses for the year. Discretionary expenses are any expenses that are necessary for daily living such as rent/mortgage, utilities, and insurance. Non-discretionary expenses are the “nice to have” items that are not essential for daily living. Subscriptions, memberships, and services are examples of non-discretionary expenses.
The categories and amounts that you enter should be what you realistically think (or know) you spend, not what you want or think you should be spending. If you are unsure of how much you typically spend on an expense category, start with your best guess. These projections can be updated as you collect more data on your actual transactions and expense categories over time.
Enter these expenses under the Expenses tab in the Annual Spending Workbook (see Instructions tab in workbook for further details).
Once you enter in these expenses, you will see the 'Monthly Expenses (Planned)' row populate with your estimated and annual expenses in the Spending Plan tab.