Tag: financial freedom

What would you do right now with $20,000.00?

Imagine it’s a $20,000.00 bonus that was unexpectedly deposited into your checking account.

No strings attached. It’s your money to do anything with.

Answering this question should be fun.

It’s a free $20,000.00!

But, my guess is that if you thought seriously about it, you didn’t have much fun at all.

Many of us likely struggled with what to do. We want to do the right thing, but we don’t know what that right thing is.

Should we pay down debt?

Should we invest?

Take a vacation?

Do nothing?

Do you have a plan for where your next dollar is going?

The reason we struggle with decisions like this is because most of us don’t have a plan for where our next dollar is going. What ends up happening is we do nothing.

Our money hits our checking account, we spend it on this or that, and pretty soon that money has disappeared. We haven’t used the money to advance any of our priorities. It’s just gone.

To me, this is one of the most important money mistakes that we need to fix right away. Having a plan for our money, before we earn it, is essential if we want to reach our goals.

With a plan, we can eliminate the disappearing dollars with confidence that our money is being used to serve our purposes.

And, that leads us to budgeting.

Budgeting is having a plan for your next dollar before you earn it.

Here, in Part 1 of our series on budgeting, we’re going to learn that the art of budgeting is having a plan for your next dollar before you earn it. That way, you avoid having disappearing dollars.

We’ll learn how to create our baseline budget based off of our current personal situation. Wherever you currently are in life, you can then make adjustments to your spending based on what you truly want.

In Part 2 of our series on budgeting, we’ll use a real life example to work through the budgeting process together. Through this example, you’ll see how even seemingly minor adjustments can make a big impact to your budget.

In Part 3, we’ll take a deep dive into my top 10 strategies for making thoughtful adjustments to our budgets so we can add more fuel to our financial and life goals.

In the end, I’ll show you how to use the information you’ve learned about yourself to create a lasting money plan that does not require you to track every penny.

What I mean is that if you can practice these budgeting tips for just a little while, you actually won’t need to budget anymore.

That’s when thinking and talking about money starts to be a lot of fun.

Let’s dive in.

Budgeting is about having a plan ahead of time.

The art of budgeting is to know what you want to do with your money before it hits your checking account.

Otherwise, it’s too late. Those dollars will disappear.

In fact, the word “budget” is synonymous with “plan”.

How do you come up with a plan?

I teach my students that to create a budget, you need to first study your own personal situation to figure out where your dollars are currently going.

Then, you can figure out a plan for how to use your next dollar before you earn it. This applies not just to bonuses or other unexpected dollars, it applies to every dollar you earn.

When you put the time in to study your own habits, you can then create a realistic budget. When you have a realistic budget, you will have confidence that your dollars are working for you.

Some dollars will be used to pay your ordinary life expenses, some dollars will be used for all the things in life you love, and some dollars will go to your financial goals.

That’s all there is to it.

Let’s take a look at three steps to take when first creating a budget.

Step 1: Track your spending for at least 3 months.

I recommend everyone, regardless of where you are in life, start with this first step of tracking your spending for at least three months.

Without knowing where your money is currently going, you won’t be able to think about adjustments.

I won’t lie to you. This step can be hard and you probably won’t like it. This is the step that makes people think budgeting is a nasty word. I get it and don’t blame you for having that reaction.

Still, there’s no getting around this first step. Remember, you don’t have to budget forever, just long enough to learn your own behaviors towards money.

Please know that many of us struggle with this first step. You might not like what you learn by tracking your spending.

When I first started budgeting, I learned that I was $20,000.00 in debt and was spending way more than I earned.

That wasn’t fun, but I’m happy that I put in the effort to find my blindspots and make adjustments.

I often think to myself, “Where would I be today if I didn’t go through this process 15 years ago? How much further into debt would I have fallen?”

Talk to your people as you go through the budgeting process.

One last thing, budgeting is one of those areas where it can really help to talk with our people along the way for support and encouragement.

You don’t have to budget in secret. We’re all in this together. Put the mental energy into this step, so you can stop wasting mental energy worrying about money and start getting energized thinking about money.

In Part 2 of our budgeting series, we’ll talk about the different ways you can track your spending. I’ve used apps, spreadsheets, and even the notes function on my phone.

The good news is, tracking your spending is easier today than it’s ever been.

Regardless of how you track your spending, be honest with yourself. If you intentionally or mistakenly leave out certain expenditures, you won’t learn where your money is actually going.

A budget, which is just a plan, is only as good as the data it’s built off of. Be honest about your data.

One quick note: Budgets are usually done monthly, so you’ll want to create a separate accounting for each month you tracked.

The reason we track three months of spending is so you’ll be able to identify any patterns or inconsistencies in your spending from month-to-month.

This helps ensure you’re making decisions based off the best data possible.

Step 2: Separate your spending into three three main categories.

Great work completing the first step! That wasn’t easy, but you did it.

Now that you have tracked your spending for three months, you can assign each expense into separate categories.

Most personal finance experts agree, though we have different names for each category, that you should divide your money into three main buckets.

I refer to these buckets as:

1. Now Money
2. Life Money
3. Later Money

1. Now Money

Now Money is what you need to pay for basic life expenses.

These expenses include housing, transportation, groceries, utilities (like internet and electricity), household goods (like toilet paper), and insurance.

These are expenses that you can’t avoid and should be relatively fixed each month.

2. Life Money

Life Money is what you are going to spend every month on things and experiences in life that you love.

This bucket includes dining out, concerts, vacations, subscriptions, gifts, and anything else that brings you joy.

We can’t be afraid to spend this money. This bucket is usually what makes life fun and exciting.

The key is to think and talk so you are spending this money consistently on things that matter to you.

3. Later Money

Later Money is what you are saving, investing, or using to pay off debt.

This bucket includes long term goals, such as retirement plan contributions (like a 401k or Roth IRA), college savings for your kids (like a 529 plan), emergency savings and paying off student loan or credit card debt.

This bucket also includes any shorter term goals, like saving for a wedding or a downpayment for a house.

Most fun of all, this bucket includes any investments you make to more quickly grow your wealth, like investing in real estate or the stock market.

You’ve probably guessed it already. Later Money is the key category that fuels your ultimate life goals, like financial independence.

The more you fuel this category, the faster you can reach your goals.

Don’t worry about assigning a percentage to each category.

I have intentionally not recommended target amounts or percentages to allocate to each of your three categories.

The reason is because of what I’ve learned from my students over the years. I’ll lay out my full reasoning in a separate post.

The short version is that in my experience working with law students, assigning target percentages for each category is counterproductive.

When I used to teach my students to aim for certain percentages in each category, I could tell that they would get discouraged as soon as I put the numbers on the slideshow. I completely understand why.

Each of us is starting in a different place. If you are currently spending 80% of your monthly income on Now Money, it’s not helpful to have someone tell you to create a budget that automatically drops that level to 50%.

My students would tune me out as soon as I put those numbers on the board.

Now, I teach my students to think and talk about their current personal realities and aim for steady and lasting improvements.

I want my students to create a plan that will last, not an unrealistic plan that they give up on after a few months.

So, whatever amount you’re currently spending in each bucket, that’s what we’re going to work with as we move on to step 3.

One other thing before you move on to step 3: don’t get hung up stressing about what type of expense goes into each category.

Sometimes, it gets tricky. Do clothes you buy for work count as Now Money or Life Money?

Don’t stress. It doesn’t really matter. It’s not worth the mental energy thinking about it. Just stay consistent and move on.

If you still want a target, aim for 20% of your income added to your Later Money each month.

All that said, I know that some of us operate better if we have a specific target in mind. If that’s you, the conventional wisdom is to aim for 20% of your income added to your Later Money each month.

Targeting 20% savings each month was popularized in Elizabeth Warren’s book, All Your Worth: The Ultimate Lifetime Money Plan, first published in 2005 (before she was Senator Warren, she was a law professor and author).

Senator Warren advocated for a 50-30-20 budget framework with 50% going to fixed costs (what I call “Now Money”), 30% going to wants (“Life Money”), and 20% going to financial goals (“Later Money”).

Most personal finance experts agree that the 50-30-20 framework is a solid plan for your budget.

In theory, I agree.

In reality, I’ve become convinced through working with my law students that the 50-30-20 framework does not cut it in today’s environment. Like me, some experts have also recognized a 60-30-10 framework may be more appropriate today.

While I agree the 60-30-10 framework is more realistic, my experience has taught me that assigning rigid percentages is just not a practical framework for most people at the beginning of budgeting process.

Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.

OK, so now that you have assigned your spending to each of the three categories, the next step is to think and talk about your current habits and whether you’re spending matches your true motivations and desires in life.

If you decide that your spending does not match your life values, then it’s time to make some adjustments. What kind of adjustments?

We’ll talk much more about how to make those adjustments in Part 2 of our budgeting series.

In essence, my budgeting philosophy is to aim for steady and lasting improvements based on your current reality and your ultimate motivations. What does that mean?

Your budget is really just about finding fuel for the best things in life.

This is where we circle back to the importance of having a clear understanding of what we want out of our money. Money is a tool. Ask yourself:

“Is your current spending aligned with how you want to use your money to fuel your goals and ambitions?”

If not, you can make incremental adjustments as you progress towards your ideal spending alignment.

The idea will be to continuously add more fuel to our Life Money and Later Money, the buckets that represent the things we love the most (Life Money) and our most important life goals (Later Money).

You can make small adjustments, which are usually easier and faster to put in place. These adjustments might include dining out a bit less, cutting out a concert, or cancelling a gym membership or subscription you don’t use.

You can also make big adjustments, like moving to a cheaper part of town or getting rid of you car.

Small or big, the key is that when you make these adjustments, you repurpose that money in a thoughtful and intentional way. You’re now starting to align your budget with your money motivations.

With each thoughtful decision, you’re progressing towards your best money life. Most importantly, you’re learning about yourself and developing lasting habits. You won’t get discouraged and give up on budgeting.

As we wrap up Part 1 in our budgeting series, keep the three initial steps in mind.

• Step 1: Track your spending for at least 3 months.
• Step 2: Separate your spending into 3 main categories.
• Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.

As you start to implement these steps, you’ll start to have a clearer picture of how your money can work for you.

And, the next time you’re asked what you would do with $20,000.00, you’ll know the answer ahead of time because you have a plan in place.

Answering the $20,000.00 question will be fun. No more anxiety-inducing, disappearing dollars.