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Budget. Its the dreaded word of personal finance. Say it, and people will tell you how much they despise it.
The statistics bear this out: Only 39 percent of US adults say they closely track their spending and have a budget, according to a 2014 survey conducted for the National Foundation for Credit Counseling. And, a recent GOBankingRates survey found that one of Americans biggest money challenges is sticking to a budget.
But is budgeting really that bad?
When I was younger and money was tight, having a budget felt like wearing a straitjacket. It was a constant reminder of what I couldnt afford: nights out, new clothes, a new car, meals other than beans and rice. However, I was thinking about it the wrong way.
Now, I see a budget as a way to afford what I want in life, not limit what I can do. This is also how Jason Vitug, founder of financial information site Phroogal, views budgeting.
A budget is a blueprint to help you get where you want to go or the life you want to live, he said.
In short, budgeting boils down to spending money on things that matter rather than wasting it on things that dont. Heres how budgeting helped me achieve the life Ive always wanted.It Helped Me Figure Out What I Really Valued and What I Didnt
People often look at a budget as something that curtails the things they enjoy, Vitug said. Thats because theyre looking at the process as a way to cut back on spending. But cutting back on spending doesnt necessarily mean eliminating all the things you enjoy; it means cutting the things that dont add any real value or enjoyment to your life.
We spend and overspend on things that do not add value to our lives, Vitug said. To start the budgeting process, you have to figure out what you actually value.
Dont compare your values to your friends and family members values, though. For example, a friend might tell you to stop buying daily lattes if you want to reduce spending. But what if coffee is something you really value and enjoy?
If it gives you the perk you need to go through your day, who am I to tell you to cut Starbucks coffee from your life? said Vitug.
Still, just remember to ask yourself whether the thing you want to buy whether its a Frappuccino or a new pair of shoes is something you really enjoy or just mindless consumption. If its the latter, its not something you value, nor will it help you achieve the life you want.
Think about the vision for your life, all your hopes and dreams and crafting an ideal lifestyle you want to live, said Vitug. That is your destination.
So perhaps what you want most is to someday start your own business or retire early. Or, maybe you want to live a life of luxury.
For example, I value family vacations because I value spending time with my kids. And because I want to be able to retire, saving for retirement is a priority for me. I treat it as a necessary expense, along with food, utilities and my mortgage. In fact, all of my priorities such as paying off my credit card balance every month, having cash to cover travel costs, etc. are where my money goes first each month.
Knowing what you value and why can help you set goals and motivate you to budget.
Related: 10 Ways to Take the Fear Out of BudgetingBudgeting Helped Me Prioritize My Spending
If youre budgeting just for the sake of budgeting, its hard to stay motivated. Thats why its important to first figure out what you value and want in life. Then, with a budget, you can allocate the money you earn toward the things you value most, said Vitug.
So, lets say the life you want involves being able to travel around the world. Create a budget that includes setting aside a certain amount at the beginning of each month to reach that goal. If you have several goals, youll have to rank them accordingly so you can figure out whether they can fit within your budget.
But what if theres not enough room in your budget to achieve your goals? Rather than think about what you need to cut, ask yourself where you can reallocate your money, said Vitug. In other words: Increase awareness to spend on things that matter.
Before making your next purchase, ask yourself if it will help you reach your goals or just leave you with less money. Maybe you really like unwinding by watching TV at night, but your dream is to travel around the world. That $100 or so youre spending each month on cable is $100 less you have saved for traveling. So, is it worth delaying your dream to watch your favorite show?
I often ask myself whether a purchase especially a big-ticket item is worth it. Im not going to lie: I value having a nice home, especially because I work from home and spend most of my day in my house. And sure, going out to eat every week would be nice. And who wouldnt want to upgrade to the newest iPhone?
However, my husband and I didnt buy the biggest house we could afford because we didnt want a large percentage of our monthly income going toward our mortgage. Instead of indulging in fancy dinners, I remind myself that Id rather have more money to pay for my kids activities, such as art classes and tennis lessons. The money spent on an iPhone could help pay for my familys next vacation, and Im going to benefit a lot more from putting an extra $100 into savings than paying for cable TV.
By knowing what I value and where I want my money to go, I dont think of limiting my spending as limiting my enjoyment of life. Instead, tracking my spending and aligning my budget with what I value has actually helped me achieve the life I want.
Keep Reading: 17 Biggest Budgeting Mistakes Youre Making
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Second, budgeting requires time and patience, much like riding a bike. Your first attempt might not go all that well, but that doesn't mean budgeting doesn't work. It means that, just like when you were learning to ride a bicycle, you need to pick yourself up and try again.
Third, tracking your spending is incredibly useful, even if you're not number-friendly. Simply looking back through all of your spending, even without adding up the numbers, can give you a real shock when you realize how you've spent so much of your money. It's well worth it to spend some time every month going through your receipts, your bank statements, and your credit card statements to see all of the places where your money has gone.
Finally, there is no quick path to riches. It doesn't exist. You're not going to budget for three months and suddenly find that all of your financial problems have resolved themselves. What you will find, however, is that some of your problems have started to abate and that if you keep it up, they will eventually disappear. This isn't a sprint-it's a marathon.
Now, onward with the strategies.Subtraction Budgeting
Subtraction budgeting is probably the easiest form of budgeting that there is. It's nothing more than a bit of addition and subtraction that you can do on a calculator on the back of an envelope, and in fact most people do some form of this already.
It's easy. Just add up all of your bills in a given month. Then, take the amount you bring home and subtract from that the total of your bills and then subtract an additional amount for savings. The remaining amount is how much you can spend in a given month.
The "savings" part serves a few purposes. For one, it helps to cover you in the event of an emergency, like a car breakdown. It can also be used to cover irregular bills, like insurance. You'll want to stick that "savings" part directly into your savings account.
But how much savings? One good way to do it is to save as much as you have to freely spend. So, if you have $400 left over after paying your bills, save $200 of it and use the remaining $200 to spend freely.
I suggest leaving the amount that you're saving in your checking account and moving it over at the end of the month, simply as accidental overdraft protection. Just remember that you need to keep your balance above that amount.
When doing this, it's important to remember all of your bills, including ones that are paid automatically. If you forget the automatic bills, you're very likely to find yourself overdrafting.
This is so easy, anyone who can manage addition and subtraction on a calculator can do it. You're just adding up numbers, then subtracting a few numbers, and that's it. It tells you how much you have to spend.Cash Budgeting
One challenge that people sometimes have with budgeting is that the money isn't directly in their hands. It's abstracted, in the form of credit cards and checks and debit cards, so they can sometimes lose track of things and not truly grasp how much-or how little-they have available for spending. When that happens, it's incredibly easy to make financial mistakes.
One great approach to solving this problem is to move to cash budgeting, which is sometimes also called envelope budgeting.
This one's also very simple (which, I suppose, is the theme here). You just do all of your budgeting in cash, or as much of it as humanly possible. You cash your check, take it home, sort out all of the dollars and cents, and then directly use that cash for everything.
Yes, for bills, it's easier to put it into your checking account and use online banking most of the time. However, for things like entertainment or groceries, cash is incredibly easy to use.
For the sake of convenience and for online purchasing, it can make sense to use some of the cash to fund a pre-purchased credit card. That card can potentially be used to pay for small recurring bills like Netflix.
What's the advantage of doing this? If you do budgeting this way, you see exactly where every single dollar goes. There's no question about where your money is going because you see every dime and hold it in your hands.
Over the course of a pay period, you can literally watch your money deplete over time. The dollars and cents get spent on all kinds of things-food, household supplies, rent, utilities, entertainment (and probably more on entertainment than you realized), and on and on and on.
When you see the money going out like that, you often start to realize that maybe some of the things you're spending money on aren't the wisest of choices, which is the real benefit of budgeting.Proportional Budgeting
This is a very clever simple budgeting technique, first introduced widely in the excellent personal finance book All Your Worth, written by Elizabeth Warren and Amelia Warren Tyagi.
The idea behind this kind of budgeting is to split all of your spending into three categories-needs, savings, and wants. Things that fall into the "needs" category include basic utilities, taxes, mortgage or rent, basic food, basic transportation, and insurance. "Wants" include things like entertainment (cable and Netflix, for example), additional food (like high quality stuff or eating out), extra rent or mortgage for a large home or apartment, extra costs for an expensive vehicle, and so on-in other words, anything that goes beyond covering your basic needs.
Proportional budgeting means that you split your money among these three categories in a very clear way. For example, you might want to spend 50% of your money on needs, 30% on wants, and 20% on savings-you could describe that as a 50/30/20 budget. On the other hand, maybe you're well off and spend only 20% on need, 50% on wants, and 30% on savings-a 20/50/30 budget.
This type of budget gets right down to the crux of two important personal finance issues that people should address in their lives.
First, it helps people clarify the difference between needs and wants in their life. The truth is that even the most frugal people often spend a lot of their money on wants, even if they define them in their head as needs. Home internet access? It's a want. Cable television? A want. A big house? Most of that is a want. A brand new car? Anything above a reliable late model used car is a want.
Because of that, it often helps people realize how large of a portion of their money is spent on fulfilling personal wants and keeping up appearances. It turns out that for most people a lot of their spending is devoted to things that really aren't necessary in life. It's spent on stuff that is there to make life more pleasurable and the truth is that none of that stuff is needed. For me, looking at things from this perspective became something of a call to get smarter with my spending and to spend less on fulfilling minor wants.
I ended up spending a lot of time thinking about how some of the things I spent my money on that would be qualified as a "want" was really important to me (like home internet access) and other things were not (like buying a Gatorade at the convenience store or buying golf clubs).
In the end, proportional budgeting is really most useful as an exercise to look at how you're actually using your money. As you're putting it together, you'll really gain a great insight into where your money is going which sets up a great opportunity to reflect on those choices.Two Bank Budgeting
"Two bank" budgeting is built around the concept of paying yourself first. In fact, that's exactly what's happening-you're putting money in the bank for yourself before you do anything else with your money.
With this type of budgeting, you start by opening a checking account at a second bank. It's in this account that your actual paycheck will be deposited in the future, so the next step is to instruct your workplace to deposit your check into this account rather than your normal one.
Once that's in place, you instruct your new bank to automatically transfer money into your old account a few days after you're paid. So, if you're paid every two weeks on a Friday, set up an automatic transfer to occur the following Wednesday or so.
Here's the trick-you don't transfer the full amount of your paycheck. Instead, you just transfer most of it-maybe $100 less than your actual paycheck.
So, let's look at a full example of this. You get paid $1,000 every two weeks. This money now goes into a checking account at a new bank. Then, a few days after that, $900 gets automatically transferred into your normal checking account. $100 remains behind in the new account each paycheck.
What happens next? You live off of the money in your normal checking account to cover the things you need and want in a given pay period. The money left behind in the other account stays there until you have an emergency or face a big expense. In other words, it serves as an emergency fund / car replacement fund / down payment fund or whatever big purpose you might have for it.
Essentially, the purpose of all of this is to automatically enforce savings in a place where it's not easily accessible. You can't just go to your local bank or use your ordinary ATM card to tap this money-it's at another bank, almost completely out of mind until you need it.
It also forces you to live on a little bit less money than before. This isn't a bad thing; it simply requires you to chop off some of your least important expenses.Automatic Budgeting
If you like this idea of automating your savings, you can take it to a grand scale and go with full automated budgeting.
To do this, you need a bank with a robust online banking system and, ideally, the ability to create "sub-accounts" to make things a little easier. Capital One 360 is a great example of this type of bank.
All you do with this kind of budgeting is set up every single bill to be paid automatically, so you don't have to worry about it. You simply set up all of your bills to be paid automatically close to the due date, as well as set up savings transfers that happen automatically.
What about extra spending, or spending on things that have an uncertain amount, or spending that happens in stores? The best method for that money is to transfer it to a central checking account, out of which you only spend money on things like food and household supplies.
At this point, this is basically the kind of budgeting that we use for our family. Almost every bill is paid automatically, and money goes automatically into separate savings accounts for various specific goals (like our next car replacement cycle) and for our overall investments for financial independence. We also set money automatically aside for "free spending," too.
Once you've got this set up, it's about as easy as can be. For us, paying bills amounts to checking the account once a week or so to make sure everything is good or to transfer money from our "free spending" account into our main checking account.
The one big trick is that if a bill is suddenly larger than normal or someone makes some bad spending choices, this whole thing can go off the rails and you can start racking up some overdrafts. You have to have good control over your spending for this to work-and a good buffer in your checking account is a good idea, too.
Another strong idea here is to make sure you have sensible overdraft protection, ideally hooked up to a savings account with a healthy balance. That way, if you do make a mistake of some kind, it's not going to impact you in a seriously negative way.Final Thoughts
Each of these strategies has benefits and flaws. Some are very simple to calculate but don't provide a whole lot of nuance or help in your day-to-day decision making. Others take a ton of up-front work but help a lot with day-to-day choices.
The overall point is this: budgeting doesn't have to be a giant spreadsheet. It doesn't have to be endless lines of numbers. It doesn't have to be endless calculations.
In the end, a budget is merely a tool to help you to reach a point where you can easily spend less than you earn, start paying off your debts, and start saving. All of these approaches manage to do that without overwhelming you with numbers.
If a bunch of columns and rows overwhelm you, don't worry. There are other approaches. Good luck.
Does Budgeting Seem Too Complex? Five Simple Alternative Strategies That Can Bring Real Results | The Simple Dollar
Trent Hamm is a personal finance writer at TheSimpleDollar.com. After pulling himself out of his own financial crisis, he founded the site in late 2006 to help others through financially difficult situations; today the site has become a finance, insurance, and retirement resource. Contact Trent at trent AT the simple dollar DOT com; please send site inquiries to inquiries AT the simple dollar DOT com. Image by Stockshoppe (Shutterstock).
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After years of therapy and feminist indoctrination, Ive accepted that my body looks the way it looks. I havent kept a food log or counted a calorie in years. I am no longer a poster girl for disordered eating. This feels like a huge blessing: I am so much happier now. But my deep-seated drive to quantify and control things has found another outlet: budgeting.
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This recent email about budgeting/planning/forecasting aka CPM - corporate performance management or EPM - enterprise performance management perfectly expresses today’s frustration among buyers:
I am struggling to really understand how the market is segmented everyone says they do everything, everyone that isn't native to the Cloud says they have a robust Cloud offering or are transitioning to the cloud, everyone (with some exceptions) says they can process large volumes of complex data, everyone says their solutions work for mid and large enterprises, a bunch of other companies that aren't CPM seem to be offering CPM-like capabilities eg Workday, and I am left with as much confusion about the market as I started.
Oh, I feel your pain dear correspondent as I've heard all of this disinformation, too. It's a mess out there. And, I fear the noise will only get amplified in the coming months. We are about to enter an era of discombobulation.
To keep things straight, I've prepared the following primer on the current and future evolution of the CPM space. Some of it is radical by today’s standards.In the beginning....
For decades there were standalone CPM products. These were spreadsheets, spreadsheet-like products and applications that could do aspects of budgeting, planning, forecasting and even consolidations.
These early products/tools had some big limitations. These solutions were rarely tightly integrated with financial and other application software products. For data to move in/out of the CPM tool, specific integration programs had to be written. Data was often extracted from a source system, translated into a standard chart of accounts, etc. Next certain global parameters would be applied to the data (eg, increase all salary costs by 3% and make the targeted revenue increase by 5%). Then, the records would be broken apart and placed into various worksheets for department heads to review and update.
The department heads usually requested the data be sent to them in a PC-spreadsheet format so that they could work on it offline. Once their work was done, the records would be uploaded to the CPM solution where some dicey consolidation work would occur. This is where you'd see things like:
- People added additional budget line items
- Two different department heads may have budgeted for the same expense/resource
This process gets really ugly in companies with matrix or fluid organizations. Just trying to figure out who really 'owns' a specific person, resource or initiative made this process a mess.
After all of this is sorted out, the budgets are reviewed, in toto. Additional macro changes are made and the revised budgets are re-sent to the department heads. This review, revise, re-distribute cycle can go on multiple times over many, many months. It saps morale and kills productivity.
But possibly the worst aspect of this world was the sheer number of different spreadsheets and tools a company used to fulfill its CPM needs. It had a budgeting tool, spreadsheets, a standalone financial consolidation tool and various business intelligence, data warehouse and reporting tools.
In summary, these early tools were only partially effective. Yes, they were better than paper but not by much. Many consolidation and reconciliation attributes weren't there. Integration with key finance and operational systems was expensive and tough to do. There were latency issues with the data and it was hard to manage all of the different versions of the truth. There were too many handoffs between systems and people.
This world had to change.And then came cloud CPM tools
In the next evolutionary stage, we saw cloud CPM products emerge. These products did a few things differently.
First, the data mostly stayed in one place: the cloud. It didn't need to keep popping out into offline spreadsheets. This enabled better collaboration between users, fewer version control problems and fewer data latency issues.
Second, these solutions were generally designed for a mobile and cloud-first world. Department heads could work on their budgets virtually anywhere they had an internet connection. They didn't need to export a budget worksheet to a laptop spreadsheet and hope that it would later upload correctly back into the budget tool.
Third, these tools didn't need any material IT support as the solutions could be implemented, for the most part, by savvy finance staff. If any IT help was needed, it was often to integrate or connect some existing financial or other applications to the cloud CPM solution.
Finally, these tools didn't need additional capital expenditures by IT. No servers, no disk storage, no systems software licenses, etc. were needed for these cloud products.
For all these reasons, sales of cloud CPM products have been strong the last several years.
But these tools have a key limitation. They weren't designed for the big data/Internet of Things (IoT) world. They were designed for industrial age ERP systems' small, transactional or financial data operating in a spreadsheet metaphor that refuses to go away.
Is it any surprise therefore that what was once a Cinderella technology Band-Aid has turned out to be a Cinderella on Steroids Band-Aid. Quicker, cheaper, faster and (arguably) more accurate but just how relevant are these solutions to modern problem solving. The simple answer is they’re not.Looking towards Generation 3
A new generation of CPM will emerge soon and it will come with a very different underpinning or foundation: in-memory computational capabilities that are married with outstanding machine learning, predictive capabilities and more. These tools will be quite different in some very material ways.
These tools will use non-conventional business data to do a better job of predicting financial outcomes across every line item of the Pamp;L. I've already documented for the American Accounting Association how this is already happening in many firms although it's mostly focused on a few line items per company today. For example, hotels can now predict their occupancy and revenue by monitoring what is happening to the online reviews (on TripAdvisor or Expedia, for example) of their properties versus those of competitors.
Training costs can be estimated by using an algorithm to assess what percent of the workforce is likely to leave the company in the next quarter. For each person that must be replaced, the company should budget additional recruiting and training costs.
Using big data (and in this context I mean business data that is the output of what today might be seen as unconventional systems), machine learning and algorithms, businesses can create far more accurate/reasonable preliminary budgets that managers can finesse. That alone can save operational leaders lots of time as it's always easier to review a prepared product that build something from scratch. This would also improve management confidence in the plans that are put forward. In short, these new approaches will allow businesses to start running meaningful Zero-Based Budgeting but without the blank sheet of paper.
Machine learning tools will keep getting smarter. These tools will understand, with a growing amount of history and other data points, how the predictions/plans can be made ever more accurate. This will be transformative as it will allow firms to get almost real-time, updated plans/forecasts based on the use of massive datasets, a wealth of history, improved correlations and unlimited computational power.
Make no mistake, we’re not there yet but that’s where we’re headed directionally.
Humans just won't be able to create as many plans in such a refined way and within similar timeframes.
This change in CPM will be profound as systems will anticipate with greater certainty than ever. This is what businesses want. They don't want a system that creates spreadsheets for managers to complete using little more than sophisticated What-If scenarios.Getting from here to there
This won't be an easy evolution for some CPM software providers. Prior generations of solutions may still be running on older relational database management systems (RDBMS) that can't perform the volume of calculations against the size of big data databases that customers will want to use. Waiting for a read-write head to move to a specific sector of a hard drive takes a lot more time than accessing data in-memory and is comparatively expensive in compute cost. So, if a CPM solution is not in-memory, it's probably going to have a limited ability to deliver a solution that incorporates non-conventional business data.
We can expect (and are already seeing) some transitory or hybrid solutions appearing. One solution I recently wrote about has cut an alliance with a cloud in-memory provider. This alliance brings a lot of data visualization capabilities to the party as well.
For those vendors with a long ETL (extract, translate and load) history, this change could be traumatic. Their strength was in technical disciplines like connecting different systems to the tool, performing data cleansing/transformation activities and parking the data into a warehouse for people to use. Their competency might not have been around understanding the customer's business. Imagine how tough it will be to create solutions involving big data and algorithms when you don't know the customers' businesses.The changing competitive landscape
With this evolution, there's also another change coming, too, and it could’ve an even bigger impact on the CPM market.
ERP stalwarts like Oracle and SAP have had their own CPM solutions for some time (eg, Oracle Hyperion, SAP BOBJ). These solutions have been getting some love lately and are part of the cloud offerings of each firm.
Financial amp; HCM software vendor Workday is developing CPM tools to complement their suite. These are due out in the Fall 2016.
Host Analytics has recently completed an alliance with cloud in-memory and data visualization vendor Qlik.
ERP vendors could have several strategic advantages, if they choose to exploit them. For example:
- Incorporate the HR organization structure tightly with the planning tool - the lack of integration is frustrating with many existing solutions as the finance system, CPM tool and HR systems have different organization charts, headcounts, etc. To budget, one must know how many people work in a given organization and who they work for. This sounds simple but it's not as some systems don't count interns, contract or contingent workers, or, on-loan internal resources to name a few. It shouldn't be problem for a company to have one book of record regarding the workforce but it often is.
- Incorporate the financial management language and structure into the CPM tool - The development of budgets/plans should follow the same chart of accounts and other reporting fields (eg, cost center, product line, country, project) used in the financial system and have the same validation rules, too. This effort should not require any re-keying or synchronization effort.
- Harness your size, mass and Ramp;D budgets to apply your knowledge of in-memory technology, big data, etc. to this space Make your current CPM offerings more relevant for the Digital Age.
- Focus your pre-existing and deep industry knowledge to create the powerful and valuable big data fed algorithms and planning predictions that will power next-gen CPM tools.
Buyers need to assess vendors across these dimensions:
- Did the vendor simply port an old product to the cloud?
- Is the vendor public cloud enabled so as to help keep costs to a minimum and afford the potential for operating based upon broadly accepted standards?
- Where are most of their product installations: on-premises, private cloud, or, public cloud?
- Does the vendor take advantage of high speed in-memory technology as the starting point for service delivery?
- Is the vendor either contemplating or actively using non-conventional business data feeds as a way of informing their predictive solutions?
- Does the vendor have machine/deep learning and/or AI algorithms that improve planning outcomes?
- How tightly integrated will the vendor’s solution be vis-à-vis my financial software? For example, Adaptive Insights appears as a tab in NetSuite's application suite.
- Has the vendor created industry templates and algorithms that reflect the nuances of information needed for the buyer’s business or industry?
Some of the solutions will take a long time to evolve to the next generation. Some could actually perish.
Smart CPM buyers will:
- Disregard regressive marketing messages from old-school vendors (eg, "The cloud is still an untested, risky thing"). Vendors touting out-of-date FUD are basically saying that they either missed the change in the market or don't have the ability to innovate to the next generation of solutions.
- Press each and every vendor for their compelling afterlife story. If the vendor can't show you anything more than a modest incremental improvement in how you budget/plan, then seek true love elsewhere. They need to be able to explain how radically different you'll be planning and forecasting in the near future using big data, IoT data, artificial intelligence, etc. If they can't describe this vision, you can bet they don't have one. Don't buy product from firms who can't anticipate and deliver what your firm will need.
- Look for lots of improvements beyond labor savings. The best CPM solutions will focus on better forecasts not just fewer keystrokes.
I expect some readers believe that all of these futuristic capabilities is the stuff that only big companies will use or could afford or that the finance department will remain stuck in its spreadsheet enabled world. Wrong!
I've seen a $100 +/- million manufacturer use in-memory cloud database technology to parse massive point of sale databases to understand the sale of their products, product sales seasonality and geographic trends, potential stock-out issues, etc. They also used the data to understand the sales and other factors behind competitor products too.
My colleagues at diginomica are using predictive algorithms and machine learning techniques to better provide information to their readers. It won’t be long before that data is used to enhance the business model.
End note: This story was enhanced with content from Den Howlett’s research into this topic.