If you’ve recently determined that you need to create a budget so you can better control your money flow, or you’ve been forced to create a budget due to credit reductions, then this may be one of the most important bits of advice you read.
Most people look at one or two months of spending when creating a budget. That’s fine for regular expenses like fuel, child care, food, dry cleaning, tuition, etc. Unfortunately, it also misses major expenses that could set your budget back by thousands if you don’t plan for them.
Finding the standards is simple:
Go through your credit card statements, receipts, check register, and bank statement to find expenses throughout the month. Total up one or two months and then average them. That should give you a good estimate of the amount you spend on groceries and other staples throughout the month.
The next category is the oddball items. These are the sorts of things that you can’t really plan for but you know they’re going to happen, like new brakes. If you have kids, there’s also the steady stream of fundraisers, field trips, birthday parties, and other expenses throughout the year.
To find these, you’re going to have to review at least six months worth of statements, a year is better if you can find them. Divide them into categories and total them up. Now divide by 12. This is the amount you should be saving monthly to cover these expenses when they arise.
Irregular Budget Items
Irregular budget items are those you do know are coming, but only happen once or twice a year. These are things like auto insurance, DMV renewals, homeowners insurance, and property tax.
Fortunately, you should know exactly when these bills are coming due. If you bought your car in December, your registration renewal is due in December. If you signed up for your policy in August, the homeowners policy renews in August. The auto policy is probably bi-yearly. Property tax depends on your locale. In most places, you pay it in two installments and these installments occur at the same time every year.
So, get out those bills and then add about 4% to each. Divide that number by 12. This is the amount you need to be putting in your savings account every month so you have the money saved to pay the bills without squeezing other parts of the budget.
Why 4%? It’s a hedge. Your auto registration will go down every year, until you buy a new car. Your auto insurance may go down every year, until they reset rates, when it could shoot up. The homeowner’s insurance will go up every year, as will the property tax. You can’t predict exactly how much it will go up or down, so saving a little extra is a good hedge against surprises, and also provides a cushion for the year you do buy a new car or house.
If you can’t find your policies or property tax bills, visit your county’s website or call your insurance company. They’ll be happy to tell you when you owe them money and look up your account to tell you the amount due.
Tracking the Money Properly
Most people only have one savings account. That’s fine. You can keep your emergency fund, vacation savings, Christmas savings, budget oddballs, and irregular budget savings in one account. Simply create separate items for each in your money management software, Excel, or on the paper where you keep your budget. Each time you make a deposit, split the payments between your non-monthly budget categories. ING Direct will actually let you create sub accounts in your primary account to make tracking easy.
Once that’s established, don’t use the budget oddball money for vacation or the irregular budget items as part of your emergency fund. A property tax bill isn’t an emergency if you plan for it. A blown engine is, and it’s unlikely that your budget oddballs fund will cover it.
Making the System Work for You
So let’s see an example of how this would work in real life.
Property tax: $5000
Auto insurance: $1600
Homeowners insurance: $1000
Auto registrations: $300
Budget oddballs: $1000
These numbers include a 4% hedge to keep them round and simple.
Divide each of these by 12:
Property tax: $416
Auto insurance: $133
Homeowners insurance: $83
Auto registration: $25
Budget oddballs: $83
That means every month, you transfer $989 to your savings account, plus whatever amount you’ve dedicated for your emergency fund. We make our transfer on the 5th of the month rather than the 1st to ensure that our paychecks are deposited without a problem and our monthly bills have cleared.
However, if you have a budget item coming up, you can deduct that money from the deposit, rather than depositing it and then taking it right back out. Apportion the rest of the money appropriately.
What If You Can’t Afford to Save?
If you can’t afford to save these items up during the year, then you can’t afford them. If you don’t pay your property tax, the county will take your home. If you don’t pay your auto insurance and get in an accident, you’ll be in big trouble. If you can’t afford these items, first look to cut things like the vacation savings. Then look for ways to reduce the oddballs. Maybe you can’t donate as much to the school this year. Christmas can be scaled down. Make sure you save the money for those items that will keep a roof of your head. It’s tough, but you’ll be happy you did it when the other option is eating rice and beans for a month straight so you can pay the property tax bill.