Creating a Budget

June 22, 2009

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

"A goal without a plan is just a wish," noted French author Antoine de Saint-Exupéry (The Little Prince). Whatever your goal might be—buying a home, educating your children or securing a comfortable retirement—the best way to avoid the trap of wishful thinking is to put a prudent plan in place and then follow it. Before you can put a savings and investment plan into place, however, you’ll first need to get a handle on your current income and expenses.

Whether you call it cash flow planning or budgeting, you might find the idea of creating a family budget about as attractive as having a root canal. But, for most of us it’s a necessary step on the way to achieving our long-term financial goals. If you’re serious about attaining your goals, then now is the time to take action. Consider the following steps as you get started:

Creating and maintaining a budget

• Record your current sources of income and expenses. Track your spending (including out-of-pocket cash expenditures) for at least 30 days. Be sure to include periodic expenses that occur less frequently, such as bimonthly utility bills, semiannual insurance premiums and annual property taxes.
  
  
  To get started, you can use the handy Monthly Budget Planner at Schwabmoneywise.com. You could also put together your own budget spreadsheet using a program like Excel, separating discretionary (fun stuff) from nondiscretionary (must-have) expenses and savings. Alternatively, you might find it worthwhile to purchase one of the pre-packaged personal finance software programs like Quicken. Your bank or credit card company may also have services to help you categorize expenses.
  
  
• Review and adjust your spending. Once you have a list of your current income and expenses, your next step is to analyze your spending and make adjustments as needed in order to meet your near- and long-term savings goals.
  
  
  Another way of looking at discretionary and nondiscretionary expenses is by categorizing them as a “need” vs. a “want.” Of course, one person’s luxury might be another’s necessity. Be as honest with yourself as you can when labeling your own expenses. Then get in the habit of asking yourself whether each of your non-routine purchases is a need or a want. It’s okay to indulge in a want now and then, as long as you’re aware of it and not acting on impulse.
  
  
  When it comes to your budget, consider paying yourself first a need. Make savings for your high-priority goals—especially retirement—a nondiscretionary budget item. We believe that the best way to save is through an automatic payroll deduction as a percentage of your wages. That way, the dollar amount of your savings will grow as your salary rises. You can put additional, non-retirement savings on autopilot as well.
  
  
• Stay on track. Financial planning is not a one-time event, but an ongoing process. So, you’ll want to keep an eye on your spending from month to month to account for any changes and make sure you’re on track towards your goals. See below for a sample monthly personal cash flow statement:

Additional tips to help you reach your goals:

• Live below your means. Saving a set percentage of your salary up front forces you to live below your means. Living below your means before retirement has a two-fold benefit: It allows you to save more for the future and reduces the size of the nest egg required to maintain your standard of living when you’re no longer willing or able to work. The alternative means growing accustomed to a lifestyle of spending you likely won't be able to support when you stop working.
• Question major expenditures. First, set a threshold for what “major” means to you. For example, depending on your income and lifestyle, the threshold might be $100. For others, it might be $1,000. Whatever the amount, before you spend the money, ask yourself if the item is a want or a need.
• Be realistic. Don’t count on an inheritance or winning the lottery to bail you out of a lifetime of spending beyond your means. Be realistic, especially when it comes to expected rate of return on your investments. You don’t want to be overly pessimistic and sacrifice more of your current lifestyle to savings than is necessary, but neither do you want to be overly optimistic and run the risk of failing to meet your goals because you thought the stock or real estate markets would do your saving for you.
• Stay balanced. It’s okay to pay attention to detail, especially when it comes to out-of-pocket cash expenditures, which are harder to keep track of, but avoid getting carried away with the bean counting. Keep in mind that a cash flow plan is only a means to end, not an end unto itself. Avoid getting so caught up in the budgeting process that you end up saving just for the sake of saving. Keep focused on your goals. Whenever you reach a saving target, reward yourself with whatever it was you were saving for. Otherwise, what’s the point?

With just a little planning and some discipline you will soon experience the fruits of your budgeting efforts. The important thing is to just get started.

As always, if you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started.