Malik S. Lee, CFP, says the three biggest reasons he sees budgets break are impulse shopping, spending too much on wants, and not saving pay raises.
Martine Beher Photography
In the age of social media, there's no shortage of industry pundits and influencers promising financial freedom with a few quick hacks. But one of the most important parts of maintaining financial wellness is also one of the most straightforward: controlling your budget.
Although it may sound simple, maintaining a budget is not an easy task — physically or psychologically. However, technology has vastly improved this labor-intensive process over the years with software like Mint or You Need A Budget.
Successfully monitoring your budget is only the first step — you've also got to stick with it. As a financial planner, I often see three common pitfalls that can pull an effective, efficient budget apart before you know it.
When most individuals begin to budget, generally they will first separate their expenses into two broad categories: discretionary vs. non-discretionary expenses. Or in other words, wants vs. needs. Either of these categories can take up their fair share of your budget and then some, particularly if you're like most Americans, who can't afford a $1,000 emergency.
Ignoring your budget or simply not making enough cash to make ends meet is often the catalyst that drives us to the silent budget killer: impulse spending.
Impulse spending is when someone makes the spontaneous or emotional decision to purchase a product or service. This is an issue that can affect many individuals living paycheck to paycheck, because impulse spending offers a sweet hit of dopamine — which might soothe stress about budgetary shortcomings. In addition, research has often shown how buying things can often reduce feelings of sadness.
However, no one is entirely immune from the desire for impulse spending. For example, MassMutual recently conducted a survey showing that Americans spent $765 a month more in the summer of 2021 than they did in the summer of 2020. Of course, some will say this is because America is more open for business post-pandemic. Still, it's fair to suspect that some of that spending was an impulsive response to pandemic-induced cabin fever.
Implementing strategies like a mandatory waiting period before purchases, reminding yourself of short and long-term financial goals, and avoiding online shopping can help if you find yourself succumbing to impulse spending.
Discretionary spending includes nonessential budget line items that vary from month to month: going to restaurants, hobbies, entertainment, vacations, and gifts. When I sit down and go over a budget with a client, they are often taken aback by how much they are spending within this category.
Since these expenses vary, the first step to understanding the impact of your discretionary spending is to review your past three months of bank statements. This exercise will allow you to compare what you are actually spending to what you initially planned on. Though the numbers may shock you, it's a worthwhile exercise.
As a basic guideline, most pundits will recommend you follow the 50-30-20 rule. This rule states that 50% of your net income goes towards fixed and essential costs like utilities, housing, groceries, 30% to discretionary spending, and the remaining 20% towards financial goals or savings like emergency funds, 401(k) contributions, and 529 plans.
While I think this is a good rule of thumb, I believe most Americans need more guidance and detailed direction when constructing a budget. This is because no one person spends the same or has the exact same wants and needs as the next person.
I believe the construction of a budget should start with your amounts earmarked for savings first, then housing, and then transportation. By employing this top-down approach, you ensure that you pay yourself first and then attack two of the largest budget categories for most people — before even getting into discretionary spending. This is an almost-guaranteed way to keep it in check.
While I am a firm believer in enjoying the fruits of your labor, I will caution you to do so in moderation. When you intentionally increase your standard of living every time your income increases, that's called the lifestyle creep.
An excellent way to avoid this is by conducting reviews of your budget at least bi-annually. This way, you can ensure that you are paying optimal prices for services and products, monitor inflation, and temper any temptation to allow lifestyle creep to seep in.
Doing these reviews and avoiding the lifestyle creep are typical habits of some of my firm's most successful clients.
