The Critical Flaw That
Causes Most Budgets To Fail
By Charles Phelan
Budgeting. It's a word we're all familiar with. Everyone knows what a budget is,
right? Yet how many of us actually make and stick to a solid monthly budget? The
truth is that most of us start out with the best of intentions, but an
unexpected expense comes up and busts our budget. Then we give up and go back to
juggling our finances and worrying about having too much month left at the end
of the money. However, if you are striving to create a budget for the purpose of
systematically paying off your debts, or to start a savings and investment
program, then it's critical to develop a workable and realistic budget.
So what's the problem? Why do most of us fail at the simple task of creating a
budget so we can live within our means? The simple truth is that most budgets
don't work because they fail to account for irregular or variable expenses.
Everyone knows how much their rent or mortgage payment is. It's the same amount
month after month. If your rent is $1,000 per month, that's a "no-brainer." The
same is true of many other fixed expenses, such as auto loan payments, cable TV
subscriptions, insurance premiums, and so on. It's easy to budget for these
expenses because the amounts don't change from one month to the next.
Besides expenses that are the exact same figure each month, there are numerous
types of expenses that vary a little from one month to the next, yet we still
have a pretty good idea what we spend each month. A good example is our grocery
bill. Most of us have a fairly clear picture of how much we spend each week at
the supermarket. So we can insert a realistic figure into our budget-
in-progress and not be too far off the mark. Sure, the amounts may go up or down
slightly each month, but we usually know the range we're dealing with. Other
examples of this category include telephone bills, utility bills, and gasoline
(although this one certainly seems to be going nowhere but up these days!).
The real culprit in busted budgets, however, is the variable or irregular
expense. How much will you spend on car repairs over the next 12 months? What
about medical bills? Home maintenance costs? It seems that bills for these types
of expenses hit us out of left field, and there goes our budget. Before long,
we're using food money to cover a new set of tires for our car, and the whole
budget comes crashing down.
So what's the solution? There is no perfect answer to this problem. But we can
come to a close approximation by using the simple technique of monthly
averaging. Start by gathering 12 months' worth of checkbook registers, bank
statements, and credit card statements. Write down (or enter into a spreadsheet)
how much you spent each and every time your money went toward something that was
not a fixed expense. Group these expenditures into categories, such as auto,
home maintenance, clothes, etc. Don't try to break it down too far. What you
want is a handful of useful categories. Then keep listing each of these expenses
under their relevant categories for the full 12-month period.
When you are done with this exercise, you should have an excellent idea of your
total annual expenditure for these variable expenses. For example, if you add up
all the automobile repair or maintenance expenses for the year, and the figure
comes to $1,200, then divide by 12 to get the result of $100 per month average.
That's how much you need to allow in your monthly budget in order to build up
enough reserves to handle an auto repair when it comes up. Again, this method
isn't perfect, because an expense may come up that exceeds your estimated
outlay, but at least it takes into account a closer approximation to reality
than simply guessing, or worse, ignoring auto maintenance in your budgeting.
The trick here is to set up a separate savings account in which to set aside
these "extra" funds. Let's say the "extra" $100 goes into the savings account
for six months, and then you get hit with an auto repair for $400. You pull the
money from your $600 savings that was purposely built up for this type of
expense. This way, you're automatically setting aside amounts intended to cover
each type of irregular expense that you encountered over the previous year.
Most people are shocked when they perform this 12-month analysis of irregular
expenses, and it immediately becomes clear why their budget is always breaking
down. This technique leads to the discipline necessary to recognize that "extra"
money is seldom really extra. If we think we have our bills covered, and there
is some cash burning a hole in our pocket, our tendency is to spend it on
something fun. But if we know that there really is no cash left over, because we
haven't yet set aside the extra $100 needed to keep our car on the road, then
we'll be less inclined to spend it on pizza, beer, and movies.
Budgeting can be successfully accomplished by this technique of monthly
averaging, especially if we consistently apply it year after year. As we move
forward, our understanding of our true expenses becomes clearer and clearer, and
we are no longer surprised by the occasional unexpected expense. The best way to
implement this approach is to set up a regular savings program, where the amount
you're setting aside to cover irregular expenses gets automatically deducted
from your paycheck and forwarded to your savings account. If the money is
deducted from your paycheck before you even see it, then you will be less
tempted to skip this critical part of the budgeting process, and you will
greatly increase the chances of making a budget work over the long term.
Charles J. Phelan has been helping consumers become debt-free without bankruptcy
since 1997. A former executive in the debt settlement industry, he teaches the
do-it-yourself method of debt negotiation. Audio-CD material plus expert
personal coaching helps consumers achieve professional results at a fraction of
the cost. http://www.zipdebt.com