The best thing one can do once you have formulated your budget is to automate the flow of cash in from your paycheck to go to exactly where you planned with your budget. My favorite way to do this is through the use of multiple or tiered checking/ savings accounts. Almost all experts agree that each dollar of income has to have a “Job”. With an automated flow you can make sure each dollar is doing its job and not being pulled into extra unnecessary expenses.
Let’s take our budget example from “How to Formulate a Budget”
With this example we have:
· $4,000 in cash income after income tax & health insurance deductions which is based on an estimated $70,000 income in a high tax state like CA or NY.
Mandatory Expenses of:
· $450 in Roth IRA Contributions
· $1,500 Rent Payment
· $250 Student Loans
· $100 Utilities Payment
· $100 Vehicle/ Renters Insurance Payment
· $100 Cell Phone Payment
· $100 Fuel for Commute
· $200 Emergency Fund
Discretionary Expenses of:
· $200 Groceries
· $150 Lunch at the office
· $400 Dinner out once per week
· $200 Entertainment
· $150 Misc.
· $100 Vacation/ Fun Savings
The easiest way to stay on budget is to make it automatic and protect yourself from yourself. If we take our example here I would suggest using 2 checking accounts and 2 savings account. If you own real estate, are saving for a down payment on a home or vehicle add accounts as necessary to effectively bucket the income. Also notice how every dollar is allocated to a bucket. It’s ok to build in a Misc. bucket. When you review your budget to actual you can evaluate where the “Misc.” dollars are going to and adjust the size of the other buckets or create a new line item if for example you regularly attend fitness classes or a gym.
Here is a visual of how the accounts would be set up:
The sum of the mandatory expenses is $2,800 and the discretionary $1,200. Assuming 2 equal paychecks a month if possible have your employer split each paycheck as $1,400 to the mandatory checking account and $1,200 to the discretionary account. Then set up auto withdrawals for the mandatory expenses & Roth IRA for dates after your paychecks will be received. Out of the mandatory account set an automatic transfer of $200 to your emergency fund savings account. Then out of the discretionary an automatic transfer of $100 to your vacation savings account.
As the months go by you can track your budget to actual progress if one of your checking accounts is consistently low with funds you aren’t following the plan. And to keep your discretionary spending in check as soon as your checking account is low you know you have to cut back until the next paycheck comes in.
If you have significant expenses that only come up once or twice a year like property tax or insurance it’s a good idea to add savings accounts for these specific items. Add a savings account transfer from the mandatory account for 1/12 of your annual property tax bill. Then come tax time the cash will be there and won’t have been eaten up by an extra vacation.