Think budgets are only for people just starting out? If so, you’re probably not familiar with what financial planning guru Michael Kitces calls “lifestyle creep”–the tendency for our spending to increase right along with our earnings. Our houses get bigger, our date nights get more elaborate, we acquire preferences for better food, cars, and clothes. We may be busier so we need to hire more helpers–dog walkers, house cleaners, and landscapers, for example.
As Kitces details in this thought-provoking post on his Nerd’s Eye View blog, that lifestyle/spending creep can be problematic from a couple of different angles. While the typical worker sees cumulative earnings growth of 127% between the ages of 25 and 55, that trajectory can be jagged; earnings often level off or even decline after the worker reaches his or her mid-50s. Income may be insufficient to support the elevated level of spending that the worker has grown accustomed to and/or crimp the ability to save.
Lifestyle creep also poses challenges from a retirement standpoint because cash flows from all sources–Social Security, pensions, and portfolio withdrawals, to name the three biggies–must support the heightened level of spending. (Few people envision radically cutting back on their lifestyles in retirement.) That’s a particular problem if overspending crimped the ability to save during the accumulation years.
To help ensure that you can meet your long-term financial goals, it’s crucial to track and manage expenses throughout your life, not just when you’re starting out and getting your financial footing. It’s also important to keep an eye on spending when you’re retired, too, as outlays rate will be a key determinant of whether your portfolio lasts over your retirement time horizon.
The best way to limit overspending and keep savings on target is to craft a budget and adhere to it. But you can’t create a budget without first getting a realistic view of your income, spending, and savings patterns right now. After analyzing that information, you can then formulate a budget that takes into account your income and any adjustments you’re willing and able to make to your expenditures.
Step 1: Create a personal cash-flow statement.
A personal cash-flow statement provides a point-in-time snapshot of what income comes into your household from your job and/or any other sources, as well as what you’re spending and saving. Only by examining your cash flows can you determine whether your spending and savings patterns align with your long-term goals.
We’ve created a Personal Cash Flow Statement worksheet to help you determine where your money is coming from–and where it’s going. You’ll need the following pieces of data to complete it.
- Most recent paycheck. (If your salary is variable, use an average of your pay over the past six to 12 months.)
- Income from other sources, such as Social Security or a pension, if retired
- Monthly investments/savings amounts
- Statements for recurrent debt, such as mortgages or bank loans
- A record of fixed and discretionary expenses. If you use an expense-tracking software program like Mint or Quicken, you should have this information at your fingertips. Alternatively, your bank’s bill-paying platform and/or credit cards statements can help determine your spending patterns.
Step 2: Calculate and analyze your personal cash flows. Subtract your expenses from your income to arrive at your monthly cash-flow surplus or deficit.
If you’re in the black and steering money to savings/investments on a regular basis, check your savings rate. Saving 10% of income is a the old rule of thumb, but in many cases that won’t be enough; 15% or 20% is a better target, especially if you’re a higher-income earner. (We’ll discuss setting and refining your savings and spending targets on Thursday.)
If you’re in the red from a monthly cash-flow standpoint, or if you’re in the black but need to find a way to increase your savings/investment rate, you’ll need to adjust your budget.
Step 3: Create a budget.
The best starting point for a budget is to identify your target savings amount, and back into a dollar amount from there. For example, say your household income is $75,000, and you’re targeting a 20% savings rate–that’s $15,000 a year.
Compare that target figure with how much you’re saving currently. If you’re setting aside $10,000, you need to find another $5,000 savings in your annual budget.
We’ve created a Budget Worksheet to help you take a closer look at each of your income and spending line items. If you’ve created a personal cash-flow statement, you can plug much of the data you collected there into the budget worksheet.
The budget worksheet includes two vertical columns for expenditures: one that depicts your current spending and the second for your target spending amounts. The left column is what it is–a record of what you’re spending currently–but you can use the second column to reflect your spending targets. Your goal should be not only to balance your household budget but also increase the amount you have earmarked for saving and investing each month.
The first page of the worksheet depicts income from all sources as well as fixed expenses; the second page reflects variable, or discretionary, expenses. Start by assessing fixed expenses; while you won’t typically be able to shake out significant savings in the fixed categories, you may be able to find a few spots to trim–for example, clothing or food expenses. Under the Utilities heading, you may be able to identify reductions in your various telecommunications expenditures by switching carriers, bundling services, cutting the (cable) cord, or taking advantage of cellphone packages for families.
In general, you’ll find more opportunities to trim among your variable expenses–dining out, entertainment, travel, and so forth. As you scrutinize each category, aim for your budget to reflect your spending aspirations and priorities. For example, perhaps you’d like to spend more on experiences and less on material goods. (Research into personal happiness indicates that people who do so are more content overall.) If so, you’d want to leave your travel expenses untouched–or possibly even boost your planned expenditures there–while cutting back on categories like clothes, home furnishings, or even your outlay for automobiles.
Step 4: Get a plan to monitor your progress.
The final step in the process is to monitor your progress toward your budget targets on an ongoing basis. If your original budget assumptions were unrealistic or if something material has changed in your household’s financial picture, adjust your budget accordingly.