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The Art of Budgeting

Forming a budget is the first step when building a solid financial foundation. The goals of a personal budget are as follows:

  • Quickly show your “before expenses” and “after expenses” estimated balance
  • Track paid vs pending expenses
  • Track upcoming expenses (forecasting)
  • Track the amount of money going to each expense
  • Identify and develop trends to optimize your budget

Keeping the budget simple and building upon it is a great way to get started. As you’ll see in the image below, one way we can keep the budget simple is by tracking only the “core” expenses. This means we’re excluding everyday items such as gas, coffee, food, etc... If you’re into that level of tracking, even better, but for this post the focus is on your core expenses.

Forming a Budget

As defined earlier, core expenses are items that have a recurring frequency or significant impact to the budget. Some examples are below:

Cell Phone
Car Payment
Credit cards
Rent/House Payment
College Loans
Property Taxes
Medical expenses
House repairs
Vet Bills

When building a budget, remember to keep it simple. It’s important to get into the budget mindset and stick to living within your means. Let’s take a look at a very simple budget example below:

While many budget templates exist, you need to find one that works best for you. The template above only tracks core income and expenses and keeps a cushion for day-to-day expenses, since trying to manage daily expenses can get a bit excessive. For the budget example above, we break down each month into two periods, 1st-15th and 16th-31st (or end of month). This means that we place expenses on the various periods based on their due dates. We try to balance the expenses so they all don’t land on the same period. As shown in the example above, we placed our “Car Payment” of $160 on the first period vs the second period since our big expense of “Rent Payment” is due on the second period. This helps ensure the paycheck on the second period has some cushion and has an added bonus of paying our car payment a bit early. It’s a good idea to set up calendar reminders to check the budget each paycheck and reassess your standing.

As expenses get paid, we highlight the cell green and change the amount in the “amount” cell to “PAID” but leave the “cost field” alone. This allows us to perform trends on expenses but still allows tracking the payment status. As expenses get marked as “PAID”, the spreadsheet will automatically update and reflect your balance. In our case, for period 1, the account has a balance of $1,211.58, but after expenses it has only cushion of $801.58. This also means that for period 1, you can spend no more than $801.58 before breaking your budget. Going over this amount will result in expenses not getting paid or dipping into savings. 

In the image above, we use the “Notes/Comments” feature in Excel to track payment notes such as confirmation numbers (in case a vendor says we didn’t pay them). It's important to note that the green highlight means the money has been deducted from your account, while the yellow highlight indicates you’ve paid the bill but the money has not left the account yet. You can add other color codes as needed.

Cutting Costs
Now that we have a basic budget setup and we're tracking core expenses each month, the next step is analyzing where your money is going, optimizing your expenses, and identifying trends. 

Identify the trends
With a month by month overlay, we can compare our core expenses each month to the previous month (or quarter) to identify spikes/dips in our core expenses. I’ve included a basic example below to help visualize what a spike would entail below:
We can see from the image above, in the month of February our electricity expense rose by $70 and our water expense rose by $50. This spike should warrant an investigation as to why these prices rose.

Cutting Costs
Outside of performing trend analysis on your budget, you can analyze any recurring or larger expenses to free up additional funds each month. Some of these items may include:

  • Refinance your house at a cheaper rate (if you have it)
  • Change cell phone providers or plans based on your usage
  • Pay off debt (we’ll cover more of this below)
  • Removing PMI from your mortgage (if you have it)
  • Shop around homeowners/renters insurance providers  (if you have it)
While our budget only includes core expenses, it's still worth exporting your bank statement at the end of each month and reviewing where your day-to-day expenditures are going and if you can cut back on a few small things. Even cutting back on something small like coffee or restaurants can save you a good sum of money over a month.

Handling Debt
While building a sizable savings account is a great goal to have, the reality is credit card interest is usually ~25% and interest on a savings accounts are usually < 1% (depending on your bank, higher rates are possible). The way I translate this is if a savings or investment account cannot yield more than the interest rate on the debt, I would pay off the debt first. If you carry large sums of high interest debt, it's a good idea to prioritize these items before other investments. Two ways commonly used to pay off debt are:

  • Avalanche: In this method, you pay the minimum amount on the smaller interest loans and use the money we save from the minimum payments to target the highest interest account. Once the highest debt is paid, you roll that payment into the next highest interest loan, including its normal monthly payment. The satisfaction of paying off the debt is longer, since you targeted the highest balance account first but has a greater impact on your budget.
  • Snowball:  In this method, you pay off the smaller loans first. As these smaller loans are paid off, you roll their payments into the next outstanding loans until all debt is paid. Since you’re targeting the smaller loans, you’ll get the satisfaction of paying off debt sooner but it will take longer to pay off higher balance loans.

A good writeup on these methods can be found at the following link below:
Developing multiple income streams
This is hands down my favorite topic, and one that I feel everyone should understand. I recall reading an article that stated “the average millionaire has around 7 income streams...”. While 7 is a pretty high number of streams to manage and obtain, if you could have 1 or 2 additional streams of revenue, that would be a great start. I would say my two favorite streams would be:
  • Brokerage account with dividend stocks
  • Peer-to-peer lending

Dividends as a stream

The high level concept of dividends is very simple, you buy shares of a company that pays dividends. The company pays you “x” amount per share you own, at some given frequency (usually quarterly). While buying shares is the easy part, below are some things to consider:

  • Research the companies before you invest in them
  • Past performance does not indicate future results (but it sure helps)
  • Be in it for the long haul (markets go up and down)
  • Use a brokerage thats supports “fractional shares” purchases
  • Use a brokerage thats supports automated investing
  • Use a brokerage that doesn’t charge fees to trade
  • Be able to tap into the stream in the event of an emergency
  • Use a brokerage that supports DRIP investing (this means they will reinvest your dividends for you).

The last bullet point is key, as the dividends compound overtime as they buy more shares, especially if you can buy partial shares. On top of this, some companies increase their dividends annually. As Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”. While this isn’t exactly “interest”, the concept is still the same, assuming you can buy fractional shares with your dividends. I'll go into dividend investing more in a later blog post, as its a deep subject and deserves its own post.

Peer-to-peer lending as a stream
P2P lending is a more risky type of investment and requires more research on your part to determine who to loan money to and how much. In a P2P lending model, the funding of a loan (or note) is divided up amongst investors. For example, a note for a $1,000 loan could be funded by 40 investors that each contribute $25. When the debtor pays their normal monthly payment, the principle and interest is returned to each of the investors over time. The amount of principle and interest varies based on how much of the note you funded and the interest of the note itself. It can take a bit of time to see results depending on the notes and their associated interest rates, but once you have a few hundred notes, you will start to see the monthly interest received grow. Once you get a steady flow of interest from note payments, you simply use the interest and principal received to either create a cushion or buy more notes, repeating the cycle. The cushion can be something simple, such as 10% of the account value. For example, if your portfolio is worth $1,000, you would have a cushion of $100. As principal/interest are received, both the value of the portfolio and cushion would increase. Some downsides to this type of investment:

  • Liquidity, it’s harder to turn your notes into immediate cash without losing some money in the process.
  • No interest on cash reserve, meaning its value would decrease over time due to inflation.

I hope this post was informative and look forward to hearing your thoughts/questions on the subject.

Disclaimer:  I am not a finance professional or licensed financial advisor. The contents above are derived from personal experience and research, and should be considered as such.


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