What are some of the biggest mistakes people make when trying to trim their budgets?
Where do I start…
One of the largest mistakes people make, by far, is creating a budget that is too complex. In an attempt to allocate each penny, which is a good thing, they create a budget that has forty five or more line items, which is not a good thing.
Don’t Go Overboard On The Details
I recently helped a client with budget counseling. When I asked to take a look at what she had, I was provided a booklet of expenses, all nicely prepared in spreadsheets.
Quite impressed, I dove in to take a closer look. She proudly showed me her attention to detail and explained the time it took, logging the amounts spent on groceries…each item on the grocery list. Tomatoes, dried pasta, toilet paper, and shampoo all had nice spots on the budget. What was not listed were the car insurance, doctor visits/co-pays, nor prescription medications. These were all some pretty hefty amounts to neglect on a budget.
I adhere to the KISS principle when it comes to budgeting: “Keep It Simple, Stupid.” Listing “Groceries” is just fine in my book.
Make Sure Your Estimates Are Adequate
Estimating low on items is another area where I see problems. Without knowing what you spend, you can’t create an accurate budget, plain and simple.
When I begin working with someone on a budget, the first thing I do is have them write down on a piece of paper where they “think” their money is going each month. Then for the next month or two, I have them actually track where each dollar is being spent.
While expenses like utilities, mortgage/rent, and vehicle payments are pretty easy to log accurately, other things like groceries, toiletries, dry cleaning, school activities, entertainment and “miscellaneous” items always seem to far exceed their original estimates.
Keeping a detailed record of each area in a budget for a month, or for a quarter, is the best way to make sure you are capturing all of your expenses. After that, you have a pretty good idea of where your cutbacks should be focused.
Remember The Periodic Expenses
Forgetting quarterly and annual expenses is another neglected area in budgeting. To ease the blow of a lump sum expense, I recommend calculating the amount on a monthly basis and setting that amount aside in a savings or separate account. It might not sound like a lot, but vehicle registrations, special events (reunions, vacations, prom, school activities, holidays, etc), and annual insurance premiums can catch you off guard if you aren’t prepared.
Another mistake people make when budgeting is not calculating the true value (or not so valuable) of recurring expenses. Let’s take Netflix as an example…
For years I subscribed to the 3-DVD-at-a-time and unlimited streaming package. This was an amazing deal while the kiddos were living at home, but the $20 and some change a month suddenly didn’t make sense once they ventured out on their own.
I ask my clients to review their recurring expenses carefully and ask this question of themselves: Are you willing to pay the full (annual) price for that same service right now?
A $10 monthly service doesn’t sound like a lot, but paying $120 upfront for the same service suddenly makes one reconsider the value of what they are receiving.
Slow and Steady Wins The Race
Budgeting is a marathon, not a sprint- Trying to accomplish everything at once will not only burn you out, but it’ll burn up your budget.
I hate to slow down the momentum some have when it comes to where to place extra funds, but taking a slower approach at times ends up being a good thing.
All too often I see people wanting to pay off debt with any extra dollars they have. I agree living a debt-free lifestyle is a pleasant thing to accomplish. However, appropriating all extra money in your budget towards paying down debt doesn’t give you anything left for emergencies that can arise.
If a proper emergency fund is not established, when something bad happens in life you will be forced to acquire even more debt, potentially at a less than desirable rate of interest. It is the whole “one step forward, two steps back” principle.
To alleviate that from potentially happening, it is best to set extra money aside in an emergency fund account (or just not touch those funds in your regular account). Figure out an adequate amount for your household, and once that goal is met, then redirect any extra funds towards debt.
For example, I feel $3,000 is an appropriate amount for my household. If I place my extra funds of $500 per month in an account for emergencies (refrigerator/air conditioner unit/stove/dishwasher/etc repair or replacement), in only six months I will have met that goal. Then I can take those $500 extra dollars and apply to repayment of debt.
Which Debt To Tackle First
Another common mistake I see is budget burnout…mostly in regards to debt repayment. More precisely, I see the most frustration arise when noticeable progress is not seen quickly.
I am asked all of the time which is better: to pay off the highest rate debt, or the highest balance debt first. The answer I give is quite simple… “I don’t know”.
I don’t know because everyone is wired differently. What may work for one might not work for the next. So the best advice that anyone can take is to know themselves, and make the choice that best suits their mentality.
Let’s say you have the following debt:
1) $5000 at 12%
2) $5000 at 15%
3) $10,000 at 10%
Regardless if you consider the highest balance, lowest balance, highest rate or lowest rate, debts 2 and 3 are your prime candidates. However, if debt 1 was from a romantic vacation you took with your now ex-significant other, that’s the one that may bug you the most. So that’s probably the one you’ll get the most satisfaction in getting rid of. I would recommend paying that one off first.
Next you’d be stuck figuring out whether to go with lowest/highest balance or lowest/highest interest rate… My suggestion: go with the lowest balance.
Shifting your extra funds to the $5,000 balance will enable you to pay that one off more quickly, allowing those funds to be appropriated towards the $10,000.
We tend to stay motivated when seeing progress, and tackling lower balances first allows us to see we’re on the right track.
Michelle Kuehner is a Registered Investment Advisor Representative and Managing Director for Personal Money Planning. She is also a Certified Credit Counselor and Certified Financial Health Counselor, writes Fix Our Budget blog, and has over 23 years of experience in the financial industry.
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