I fear that much of my financial advice might be directed toward people who are older and have already achieved a reasonable degree of financial success. Those folks are more likely to be able to afford large interest-only mortgages, expensive luxury cars and be able to plunk down 30 grand for solar panels to save even more money.
There are several financial strategies that can actually benefit younger people more than older people. One of those would be a strong knowledge of household budgeting, how to practice household budgeting and benefit from it. If you are older and the original benefits of a sound household budget are in place you can always pass this message onto younger folks who might benefit.
You’ll be hard-pressed to find any financial recommendations that don’t say everyone needs to be able to budget their revenues and expenses. Having a household budget falls into the category of, don’t smoke, don’t drink too much, don’t eat too much and eat lots of vegetables.
I have a standard response when a waif-like 103-pound 5’6” restaurant server asks me which of the vegetables would be my choice to go along with my entrée. I simply respond with, “I don’t want any vegetables. I’ve read the vegetables are bad for you!”. I do this just to generate the reaction that I almost always get. It’s a puzzled look. It’s a look that has no response. Well, I’m sure the slender young server WANTS to respond with her theories on vegetables but she has a financial strategy she doesn’t want to jeopardize….her tip. Try it sometime.
When you read that you should be practicing household budgeting it sounds easy doesn’t it? “Don’t smoke” to the non-smoker sounds pretty easy. “Don’t overeat” sounds pretty easy to the one person in 1,000 who has an acceptable “ BMI”.
I think of using an effective household budget as a way not to get poor. Staying within your budget is really not a way to get rich. How do you get rich? You need to be an owner of something. Not many people get rich being a wage earner. Being a wage earner helps you avoid being poor. It’s just not so much of a path toward getting rich.
Today we will talk about using household budgeting as one of the strategies to meet your financial or life goals. Later in this message, we will discuss “owning stuff” which will put you on your way to being wealthy. As we do this I’ll share some of my own personal experiences to give you an idea about what I’m talking.
I think it’s important that everyone has a goal they want to reach in just about every area of their life. My main financial goal was pretty simple.
I just wanted to acquire enough financial resources to be able to stop working at a very young age. Then I wanted those financial resources to sustain themselves throughout my normal IRS projected lifespan.
I feel that I’ve been reasonably successful in planning for and then achieving that particular goal. I retired at age 52. We’ve had enough financial support from the strategies I used throughout my life to be able to go on vacation 150-200 nights a year for each of my 20 years of retirement. Actually, our financial reserves are about the same today as they were when I retired. I often look back on that particular statistic with amazement.
In summary of what I’ve shared so far, I will say that first, you have to have a goal. Then you have to use household budgeting as part of your financial arsenal to achieve that goal. You won’t get rich knowing how to use a budget but for sure you won’t get poor. Now, exactly what am I talking about as regards household budgets, how do they work and how do you do it every day of your life?
In most cases, you don’t want to spend more money than you make. Duh, right? To be sure you don’t have to gamble your money away in Las Vegas, waste it on fancy clothes, cars, restaurants, or anything like that to go deeply into debt.
Let’s say you make $30,000 a year. That’s only $15 an hour. Then let’s say that you overspend your income by just 10% or $3,000 a year. Spending an extra $3,000 is not difficult to do. You could have unexpected medical expenses, or car repairs or car depreciation or just plain wasteful spending. You could probably blow an extra three grand pretty easily.
Wait! How could you have an “expense” for car depreciation? Your car’s depreciation is a “silent” expense that many people don’t consider. Let’s say you bought your car new for $30,000. Then three years later the car’s value has depreciated to $18,000. That’s a $12,000 expense over 36 months or about $333/month. Most people, including me, don’t add that expense to their household budget spreadsheets.
You’re going to have to make a decision about how you budget for something like depreciation or an unexpected expense like a major roof repair or a car accident that requires a big expense.
Additionally, you’re going to have to have a plan for what you budget for each category. That’s very important.
Here’s how I do it. Carol doesn’t have a car payment right now. However, sometime in the future, she will. If I think she will be getting a new car in two years I budget the expected amount of that car payment in my budget two years from now. That monthly car payment is budgeted for each month of the expected loan term.
By way you have an estimated budget covering two years from now don’t you? My future budgeting estimates go out 15 years into the future based upon expected increases and lifestyle changes by category.
Yes, I have projected budgets out over the next 15 YEARS! If I think an expense like medical is going to increase by 5% each year then each year’s budget for medical will increase by 5% per year…for the next 15 years. Some expenses for us like electric, home mortgage, car payment and the like are fixed. They won’t inflate each year.
Some expenses are known such as our home mortgage or car payments. In those cases, I will simply add those amounts for every future month until those loan terms are finished.
With budgeting and budgeting tracking it’s important to do two things. First, establish a monthly budget based upon historical information AND any KNOWN information I have that might be more accurate than using what happened last year. Some items like auto insurance are only paid two times during the year. In that example, I’ll budget what our car insurance is expected to be for those two months. All of the other months, for car insurance, will be zero.
By having a number, even if it is zero, in every month for every category for the next 15 years I can project my cash flow for the next 15 years. I don’t expect these projections to be perfectly accurate. It’s impossible to predict the future. However, my projections will be “directionally accurate” and that’s close enough for me.
Here’s another way to think about overspending your income. If you earned $30,000 a year but spent $33,000 a year after just five years you wouldn’t be just $15,000 in debt. Assuming that extra spending came from credit cards or from investment accounts your true debt after five years would be $20,000 or more.
With credit card interest at say 20% on $20,000 in a year that interest expense would be $4,000. Having an extra $4.000 expense when you’re only making $30,000 a year is a pretty big deal. The point being is that you don’t have to spend very much money above what you make to be in a pretty significant debt situation in a short time. Successful household budgeting prevents that problem.
You might not believe this statement but I can account for every copper penny that is spent in the Lewis household. I have some systems in place that allow me to do that without spending very much time doing it. I’ve been using electronic spreadsheets to track our financial spending for the past 30 years. Prior to that, I used a pen and paper.
There are programs like Quicken, Mint and YNAB that automate much of this work. Since I’ve used Excel nearly from the beginning I’m comfortable with that. The main point is to figure out a way to accurately track your expenses.
I have about fifteen expense categories to use with our household budget. You could select far fewer or far more groups of expenses if you wanted to. I found that a dozen or a little more works for me.
By the way, this is how finances work in our household. In our lifetime I’ve made 99.9% of the money. When I got that money I gave it to Carol. That seemed to work for her. She writes the checks. I manage the financial strategy.
These are the household budgeting categories that I use.
Home mortgage
Real estate taxes
Electric
Phone
Water/sewer/trash
Insurance
Direct TV & Internet
Gas (heating, not auto gasoline)
Federal income taxes
State income taxes
Credit cards/checks
Vacation/Entertainment
Home improvement
Medical
Randy’s auto payment
Carol’s auto payment
I don’t think there would be much value in telling you how much we budget in each of these categories. However, it might be worthwhile to share what percentage each of these expense categories makes up of our total budget. Here’s what that looks like.
Home mortgage – 26.9% I strongly advocate that almost everyone should have as large of a mortgage as they can pay for. Let’s say you own a $400,000 home with a $200,000 mortgage. That means you have $200,000 in equity. The payment on your $200,000 mortgage is simply a payment to have control of the OTHER $200,000 in equity that is not sitting idly in your OTHER home equity earning nothing. Get as big of a mortgage as you can and invest that money. We currently have a 10-year interest-only jumbo (no…really jumbo) loan at 2.25%. I would have no interest in paying that off any quicker than required because I can earn so much more investing these funds rather than pouring them into home equity.
Real estate taxes 9.0% California charges roughly 1% of the original home’s purchase price for real estate taxes. Then those taxes can only go up 2% a year. If you build a house the tax authorities appraise your house at completion. If you get a favorable appraisal, as we did, your base will be much lower but still subject to a maximum 2% increase each year.
Electric – 0%! That’s right zero percent. We have solar panels that reduce our electrical expenses to nothing. If we didn’t have solar our average monthly electric bill would be about $500/month. It took 4 ½ years for our solar savings to pay off the total cost of solar. Now it’s all sunshine!
Phone – 1.0% Covers one landline (I keep trying to get Carol to drop this) and two cell phones with every conceivable option included.
Water/sewer/trash – 0.6% To be honest I have absolutely no idea when the trashman comes each week…but I have people who do.
Insurance – 5.0% This covers home, auto, umbrella and earthquake insurance. Hope I don’t have to ever use the earthquake insurance. The earthquake insurance comes with a 10% deductible of the home’s value to reconstruct.
Direct TV & Internet – 1.1% I don’t get streaming as a way of saving money. I don’t want to waste money but I also don’t want any of my viewing options or conveniences to be limited to try to reduce a 1.1% expense.
Gas (heating, not auto gasoline) – 0.4% I think we only use gas for our home heat. But then again you would have to ask my people about that. There are some homeowner details I just don’t get into.
Federal income taxes – 3.5% This changes by small amounts each year. You will never ever hear me complain about taxes. The only guys who complain about taxes that I know are doing it over a large plate of linguini with a glass of red wine at lunch at the golf club. Then when they finish complaining they hop in their luxury car and drive two miles back to their million-dollar-plus homes. I’ll pay the taxes I owe in the hopes this very minor redistribution of wealth goes to the people who need it so they don’t come to my house and try to take my stuff.
State income taxes 0.4% Like I say this can vary just a bit from year to year. My California income taxes don’t seem like much considering I live in a “high state income tax” state. You can’t believe everything you read unless it’s in my newsletter! Yes, for the past two years we have not owed a single penny in California state income taxes!
Credit cards/checks – 16.9% This is an important category. It’s sort of a “catch-all” category. Any expense that can’t be put in one of the other categories goes here.
Vacation/Entertainment – 18.2% Yep. It’s true. We really do shell out nearly twenty dollars out of every $100 we spend on “vacation and entertainment”. I am not exaggerating when I tell you we have been to nearly 100 countries, stayed in hotels 150-200 nights every year, flown on 200+ airplanes every year and rented 50-75 cars each year during my 20 years of retirement. Despite the discounts and deals, I get on travel it can still costs quite a bit.
Home improvement – 7.1% This year our home improvement expenses have been higher than normal. Examples of this expense might be getting a new air-conditioner or retiling our decks, etc.
Medical – 2.5% We’re on Medicare, which if you have a really good company health care plan is about the same out of the pocket expense. We also have company retirement health care for those catastrophic medical expenses that might come along that Medicare wouldn’t cover.
Randy’s auto payment 7.5% I have a very large monthly automobile payment at an interest rate of 1.99% for six years. How large? Probably larger than you would be imagining. However, about 90% of each payment goes to equity in the car. The car is depreciating on the one hand and my loan payments are increasing my equity in the car at the same time. At the end of the six-year loan, my car might be worth half of what I paid for it. So about half of this “7.5% auto expense” isn’t really an expense…it’s building equity. The last thing, just like with my home mortgage loan, I would ever want to do is pay off this 1.99% loan early when I can invest the money all along for much more. Gasoline falls into this category as well. However, I have an electric car (Tesla) so no gasoline expense. This cuts down on data entry!
Carol’s auto payment – 0.0% Carol doesn’t have a loan on her car. She drives a 2014 Lexus RX 430 (bought new for her) with about 30,000 miles on the odometer. You can get in line to buy this car when she’s ready for a new one. I’m trying to get her into an electric car but she is resisting. I always get more than Kelly Blue Book value when I sell our used cars on Craig’s List because they are in pristine condition.
Here’s why you need a budget.
It’s not difficult to create a household budget. You pick your own categories and at the end of the month you just simply figure out how much you spent on each of those categories. You have to make absolutely certain that there are no leaks in your bucket. EVERY expense has to be allocated to one of your categories.
I would recommend that people, especially young people, have an investment category. If a person could put 10-20% of their income into investments at a very young age by the time retirement came along they could have hundreds of thousands if not something in the millions of dollars. The power of compounding for young people is their biggest financial advantage.
Let’s say that you put $200 of your income every month into a investment category. Then after a year, not counting investment returns, you would have $2,400 in that investment account. Then if you went to Costco and bought one of their very best TVs for $2,400 you didn’t really put $200 a month into investments. You put that $200 a month into your flat-screen TV budget category!
I recommend that people create and maintain a household budget for the main reason of not overspending their income. If you get into credit card debt and well over half of all Americans are in credit card debt that means you overspent your income. Bad idea. Actually, that’s a really bad idea.
As I mentioned earlier creating and maintaining a household budget is not going to make you rich. If you overspend your income doing that could make you poor. Having a budget mainly keeps you from being poor.
How do you get rich or at least wealthy enough to reach whatever goal you established for your financial life? Remember, my financial goal was to be able to retire early, live a leisurely vacation-filled lifestyle and never run out of money.
How did I do that? I owned stuff. One of the best ways to create wealth is to own your own home. If you live in the right places and own a home for a long enough time frame you’re likely going to accumulate some pretty good wealth. The strategy has worked very well for us.
However, if you buy a house and it appreciates in value the only way you can enjoy that financial appreciation is to take equity out of your house. That means getting a loan. As I have mentioned in various other newsletters getting a loan even into your retirement years is actually a very prudent financial strategy. Paying off your house…that’s a bad idea. Dave Ramsey is way off on this one. Remember Dave Ramsey didn’t get rich by avoiding debt. He got rich by having a radio and TV program that told other people to avoid debt! There’s a difference.
We have also used another financial strategy over the years to accumulate wealth which is related to owning homes. We bought rental properties, although I hate being a landlord, and made money doing that. Was the money I made on rental properties worth being a landlord. I didn’t think so. I’m actually pretty lazy.
My company had a profit-sharing program. They contributed as much as 27% of my salary in later years into this profit-sharing account. I never touched those funds, mainly because the rules wouldn’t allow it (which was a good thing!) until I retired. Those 27% company contributions were given to us in company stock. The company stock was appreciating at 10-15% a year. That got to be a pretty wide number after a while.
I worked for 30 years at Procter & Gamble. Most people at Procter & Gamble are very loyal to the company. That means their profit-sharing account during their employment years was filled with only one stock. That would be Procter & Gamble stock.
Then when many of those people retired, again because they were loyal to the company, they maintained the lion’s share of their investment money in one stock, P&G. Bad idea. Really bad idea. That’s not a knock on Procter and Gamble. It’s a knock on the idea of having well over half of your investments tied up in one stock. Yep. Really bad idea.
During my 20 years of retirement, I have consistently invested my retirement assets in a broadly diversified stock and bond portfolio. That portfolio has earned an average annualized rate of return of 9.2% which is pretty outstanding if I don’t mind saying so myself.
By the way, I don’t use or pay for financial planners. I don’t have to. I know how to manage and invest money. However, not everyone can handle finances really well. If you’re in that category it might be a good idea to get a financial planner. I can only imagine how much I would have paid a financial planner to help manage my money. That would have been a big number.
I have also invested in other financial, mainly real estate, projects. Some did well and some did not.
By maintaining a household budget you won’t go broke. By owning stuff like houses, rental properties, stocks and bonds and equity positions in other real estate projects you can get wealthy. Be an owner whenever you can!
This is not to say that being an owner is risk-free. I once lost $90,000 with a Procter & Gamble stock option because I held out trying to get that extra dollar. That proved disastrous. I lost another $135,000 on a single stock bet. Then I lost another $500,000 or more investing in a company that ended up going bankrupt. You won’t make money if you don’t risk it. You just hope that the risk isn’t too great.
Summary. If you are older and you overspend whatever money you are making and have savings and investments to cover that overspending you don’t have a problem. As long as you can plan to die before that becomes an extreme issue you’ll be OK… sort of. But…you’ll be dead but you would have proved your point!
For the younger people reading this having a household budget is critical. Each year you’ll want to make sure that you don’t overspend whatever income you are making. If you’re good with spreadsheets you can actually apply an inflation factor to each of your budget expense categories. That will project your cash flow well into the future.
If you are younger and can save 10-20% of your income, invest it wisely and never touch it until you retire you’ll be ahead of 99.97% of your friends. Very few people can do that…but for the people who have the proper financial self-discipline, they will become big winners.
In your spare time I recommend doing this. There will be some “educated guessing” to do. First figure out how much you have investments today. Then try to guess what rate of return you can earn from now until you retire. Guess how long you expect to be in retirement. Guess how old you will be when you die. Try to figure out how much you will need to spend when you retire so that retirement can be a fun time not a stressful time worrying about money. I know…there are a lot of guesses required here. No one can predict the future. You can only guess what the future might be like. The folks who can’t figure out what I’m saying in this paragraph are likely to do less well than the folks who can handle this paragraph. Why do I say that? Because it’s true!
Finally, if you are younger try to own stuff as soon as you can. Get a house. Get some rental houses. Invest your 10-20% savings in a broadly diversified stock and bond portfolio but mainly in a stock portfolio.
Finally, have a realistic financial goal for yourself. Understand how long it will take to reach your financial goal, how much effort and funds it will take to get there and monitor your results frequently.
Everybody will have a different financial goal based upon their circumstances. I have shared the above information with you to indicate that if you have a specific goal as I did, you can reach it with proper planning. Right now if you don’t have a very specific data-based household budget I highly recommend you get one.
If you read this far I hope you’ve enjoyed and maybe learned something from what I have shared. This sounds simple. Trust me it’s not. In the meantime, if you have any questions I’m only an email away.
