Go to any financial planning or investments web site and you’ll be encouraged to create a budget. Write down all your expenses and plan what assets (dollars) you will need for the next week, month, and year. To assist you, these providers often attach worksheets to help in the process.
If budgeting is so simple, in theory, why do so few people benefit as a result of creating this type of plan?
About fifteen years ago I had the privilege of seeing professional financial planner David Chilton. He was supporting a book called “The Wealthy Barber: Everyone’s Common Sense Guide to Becoming Financially Independent.” Part financial planner, part shtick, Chilton was actually a fairly intelligent guy. Unfortunately for Chilton, his ideas on financial planning fell on deaf ears as his image was out of sync for the masses who suddenly craved cocktail parties to boast tales of tech stock mastery.
Yet, there was one part of David Chilton’s presentation that struck me. Its lesson is as important today as it was then. According to Chilton, budgeting is nothing more than a myth.
But how could this be? Aren’t we taught from an early age that having a budget is essential to financial success?
Not so fast. In my experience as a financial planner, most people attempt to put pen to paper and plan or create a budget only to abandon their strategy just a few months later.
Why, you ask?
It was something that Chilton understood that major financial institutions didn’t want to talk about – conceptually, a budget just couldn’t account for emergencies. Exactly, how do you plan for a leaky roof? What about a major medical payment? Or buying a new car if you have an accident?
I believe Chilton was spot on. Adhere to a budget and you are bound to be frustrated sooner or later.
The key to the planning Chilton refers to falls squarely on the shoulders of spending habits.
There are two types on expenses (spending) we often talk about as planners – non-discretionary and discretionary.
Non-discretionary (essentials) expenses are life’s necessities. We all need food, clothing, and shelter. We need to heat our homes and educate children. For most of us, we need transportation to get to and from work. Health care would be considered a non-discretionary expense.
Discretionary items are life’s luxuries. They can range anywhere from vacations to coffee and everything in between. These are often the ‘danger’ items which cause short-falls in our planning. We all have them.
Therefore, the key lies in understanding the difference between the two.
It is paramount to live within your means. That is, own necessities (house, car, etc.) that meet your needs and your budget. Non-discretionary items and other expenses associated with them can be outrageously costly (think taxes, repairs). So the next time you consider the purchase of a car, carefully weigh the expense of owning a Mercedes versus that Mustang. These considerations need to be made with every discretionary purchase with a revolving payment or upkeep costs.
After this is completed, discretionary expenses actually become quite easy in determining their viability in life. Europe or hiking in Nevada? Go to Starbucks or make coffee at home?
In reality, we all need a handle on our expenses. Quite honestly, this is a form of budgeting. However, until people learn flexibility and accept the fact that this type of plan is nothing more than a directionally accurate guide, they will continue to be frustrated.
There’s where the greatest danger lies. After all, having no plan is the worst plan of all.