One of the basic principles to reach Financial Independence is to live below your means. In order to do so, you need to know how much you spend. Or even better, put your spending on a budget. This way, you are almost sure to save and invest. I will share what I have learned so far.
I started to budget in 2002. We are now 2015 and I still budget, but in a different way. Over time, I have developed my own system to keep track of my spending and to make sure that I keep investing by paying myself first. Indeed, paying myself first is the basis of my budget. I make sure I invest each month. Off course, this is only possible if I know how much budget I need to live on. Sounds like the chicken and the egg? What was there first?
Key budgeting principles
Pay yourself first
In order to make sure that we save and invest according to plan, we pay ourself first. This means that we set aside automatically each month our emergency fund contributions, 1/12th of recurring expenses and the minimum amount we plan to invest. This way, the money is directly where it needs to be and we make sure we reach our goals. For me, this is key. Any reason I see not to do this, is a wrong reason.
How can we do this? Well, here are some things that are important to be able to do this
- `have faith in your budget. This might require a few months, but if you really want to achieve results, you will get there soon. Below I detail how we got to trust our budget
- Have an emergency fund: If something comes up that we did not expect, we use the emergency fund. This way, we are not obliged to sell assets at the wrong time.
- Plan ahead regular recurring expenses. Think of items like insurance that only bills once a year, or property tax (In Belgium, it is billed only once). Divide the expected amount by 12 and put that aside each month. Keep track per item how much you already have saved. When the bill comes, you can stay zen. Off course, these payments are counted each month in the expenses.
A budget without regular follow up remains a dream, it can even turn into a fata morgana. Therefore, it is key to follow up on a regular basis the spending vs the plan. Does this means daily? Probably not, does this means once a month? Surely not. Something between 2 times a week and once every week should be fine. The aim is that you know where you are according to plan.
The great thing about it is that your brain and habits start to adapt to this. First it becomes natural to update regularly. After that, you start to develop some internal calculator and you know upfront what the result of the check will be. Isn’t that great?
One principle that I developed overtime is overflow. In short, I do not invest at the end of the month the money that is unspent in our current account. In stead, I leave it on the account. This means that next month, we have some extra budget to spend. Is this not splurging?
I do not see it as splurging. Some months are more expensive than others: inviting friends or family for dinner, eating out,… These are essential elements in life. Without it, the journey to FIRE would be too dull for me.
I often reserver that money in the budget for holiday expenses or oncoming big events. Our budgeting xls has room for this (Rereading this, I get a nerd alert 😉 )
If the amount becomes too big compared to the expenses I see coming, than it goes into the invest account.
How I got to the current budget rules and xls
Long ago, when I moved into my apartment, I was spending money on I do not know what. As a result, I lived from pay check to pay check, each month. Sometimes even using my savings to reach the end of the month. I might have been often for the good reasons – decorating the apartment and paying for services related to moving in. But still, it felt awkward.
Time to budget
I started to look at my past spending and made a list of recurring budget items. The usual suspects: food, car insurance, gas for the car, entertainment, insurance for the apartment, mortgage. I also foresaw room for savings and for an emergency fund. So, it seems that already then, I was applying the FIRE rules. I should thank my past me for that.
Here is how the xls looked like at that time: (Numbers are samples)
How was it constructed
For each item I made an educated guess and that became the basis of my budget. It took a few months to calibrate, but I got to the point where I knew what I was spending my money on. The xls sheet also gave me the amount of money available that month for food and discretionary spending. This was calculated automatically based upon the data entered.
Paying for holidays: certain financial windfalls were set said on the savings account and labeled as holiday. At the time of holiday talks with friends, it was fairly easy to decide if I had the money or not. I remember that holidays were a priority for me. So, that fund always was well taken care of. It allowed travel to South America, Asia, Ibiza.
The budget also had a line item for expenses that I would anticipate or that were paid with a credit card. I call this the reservations.This line allowed me to keep my monthly budget under control while using a creditcard. This is needed as credit card expenses don’t get booked at the time of purchase. You need however the account for the expense if you want to avoid a negative surprise.
As you might notice, at that time I was not busy yet with Financial independence and early retirement. I was happy to save, but the money piled up in my savings account. I only occasionally invested. In the back of my mind, I was saving for a down payment on a house.
When my girlfriend moved in, I kept doing the same, but only for my personal expenses. We had an arrangement in place where it was clear who needed to pay for what. At that time, there was no common account yet. For us, it worked. In short, I paid for the apartment and related expenses and she would paid for the food. Entertainment was unclear, but never a discussion.
Getting a house and kids
We started to look for a house. At that time, we needed to know the numbers of us together. For the purpose, I made a xls sheet that maps out the expected income and costs that we would have when living together. Knowing my own costs from the past, and using the data from my girlfriend, it was quite easy to build a budget that would make sense. Having the numbers, we had an idea on how much we could borrow.
I also extended my budget process to cover for yearly recurring costs. These costs are simply divided in 12 and 1 twelfth is put on a savings account each month. When the bill hits, it is without pain that I could pay.
The key elements of the budget remained the same, but now we had a joint account. We each paid into that account our fair share. What was left over after that, was available to us, as we saw fit.
When the kids and daycare came, there were some shifts in the budget, but the main concepts remained.
The current budget
Now that we are both into financial independence and early retirement to mainly travel, things have changed a little.
- If there is an s in this column, then this expense is 1/12th of an annual bill. Example: we pay our home insurance every year, but each month, I set aside 1/12th
- There are some conditional formats build in. If in a month we go over the foreseen budget, then the line turns red
- This line is used for making reservations as mentioned above, or to keep track of the overflow. Typically, credit card expenses go here we pay off our credit card each month, we do not use the credit as such). The overflow is also noted here. Imagine that one month there is 100€ unspent, and there is a weekend trip coming, then the 100€ goes into the reservations, earmarked for the weekend trip.
- The extra cash line show how far we are under or over budget compared to the expected average spending per day. This helps to see if we need to pay extra attention or that all is fine.
The joint account and house budget still stands. It is in the personal budgets that we have made the changes. we now each get an agreed personal monthly budget. As usual, I keep track of it, but now without full details.
The delta between our contribution to the common budget and the personal budget is now invested as well each month. Doing this will allow us to reach FIRE by 2029.
Do you have some budget tips to share?