What is keeping you from the American Dream – Part 2 – Lack of a Financial Plan

Nothing can be accomplished without deliberate action. Even to win a lottery, you need to go to a store and buy a ticket. Assuming that winning the lottery is not your financial plan and you are actually willing to put in the work it takes, you will need to create a formalized plan to reach financial independence (and more importantly, stay there). You need the discipline because, there is enough evidence to prove that the lack of the financial discipline and planning is the exact reason lottery winners go broke in a few years.

Many people dream of achieving the milestone of millionaire status. While it is an achievement, its not like a mariachi band is going to show up or confetti will rain down when the moment arrives. In fact, you realize it is just another Tuesday and you go back to whatever it was you were doing before it happened. So let us start by addressing the most important aspect of a sound financial plan. THE BUDGET.

Let me just say outright that without a budget, you cannot and will not achieve lasting financial success. It is vital to understand how much money you bring in and even more essential to know and control, when, where and how it goes out. More importantly, you need to know what is the ratio of the inflow to the outflow (If that ratio is not greater than 1, or in other words, if you spend more than you make, an intervention needs to happen right now). Below are a few steps you can take right now to get started towards a disciplined approach to your finances.

Step 1: Calculate Income vs Spend

Figure out what you’ve done over the last few months with you finances. This will give you an understanding of just how many changes you will need to make. I recommend looking at your 3 most recent pay-stubs and figuring out just how much money comes in every paycheck. I suggest budgeting every 15 days since, I feel a whole month is too long to go without a check in. A lot of indiscipline can creep in over 30 days and you are less likely to stick to it. Budgeting weekly is too much of an overkill and is likely going to burn you out. Plus most people get paid every 15 days or every two weeks so it works pretty well.

Now that you’re done with the easy part, it is time for the uncomfortable bit.

Dig up those bank and credit card statements and look at how much you spent each 15 day period for the last 3 cycles. Don’t worry about what you spent it on. Just add it all up. Now compare it with the number on your paycheck. Did you make more than you spent? Or did you spend more than you made? This information will tell you where you stand.

Step 2: Figure out what you spend on

Now look at the credit card and bank statements and start categorizing where you spent those paychecks. Open an excel sheet (or a google sheet) and create categories for Rent/Mortgage, Phone bill, Utilities, Groceries, Gasoline, Internet and put them under a master category called ‘Essentials’. These are things that you cannot live without and should take the utmost priority when it comes to demands on your paycheck. Start with your income and subtract each item from the essentials category from your income as you go until all the ‘Essential’ items are complete.

The screenshots below shows you what I am talking about. This sample shows someone who makes $6,000 a month in take home earnings but still only saves $250 each month. Is this what you found?

If you’d like the excel version of this document, feel free to contact me from the ‘Contact Us’ page and I will be happy to share it with you.

Sample Past Spending – Essential Category

Once you’ve filled out all of the essential categories, start filling out the second section – Discretionary spending shown in the screenshot below

Sample Past Spending – Discretionary Category

Below is a breakdown of the spend in each sub-category in comparison with what experts recommend.

Step 3: Create your ideal budget

Now look towards the future and craft what you want to happen. Let me show you a sample where someone who makes only $4400 in take home earnings a month can save $1000 a month by planning and staying with a budget.

Essentials Section of an ideal Budget

A few things to note about essential items here.

  1. Since you are starting out, there are likely some items in the ‘Debts’ category. You need to eliminate this category as quickly as you possibly can
  2. Savings is on the top of the ‘Essential’ category. You need to pay yourself before you pay anyone else.
  3. The food category does not include Restaurants – Restaurants are not essential to your survival
  4. There is a ‘car replacement’ sub-category. It is blank now, but what you pay for your car loan payment should actually go towards saving for your car replacement while you drive your current car. I’ve addressed why, what you drive is so important in Part 1 of this series.

Below is the ‘Discretionary’ section of a well thought out budget.

Discretionary section of an ideal budget

Few things to note here

  1. There is money set aside for Charity. No matter what you make, you can always give. Trust me when I say, it comes back many times over when you give to someone in need and there is always someone who needs it more than we do.
  2. Restaurants are discretionary.
  3. You still get money for impulse spend. It is just limited.

Finally, below are the percentage breakouts of how this budget compares with the recommended spending percentages by categories.

Percentage breakouts of an ideal budget

While retrospecting on our past bad habits is extremely difficult, it is crucial to know them so you understand what needs to change for us to redirect our focus to what is truly important.

As for my wife and I, we’ve been budgeting twice a month for over 8 years and I could literally tell look up and figure out how much I spent at restaurants in the year 2013. That type of knowledge really helps you keep tabs on what you are doing.

Please let me know if you have any comments or questions and I will be happy to answer them in the comments section below. I can also provide you with the excel files for these budgets if you’d like.

If you like the content, please consider subscribing.

2 comments

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s