Everyone needs a budget, right? There’s even a handy acronym: “YNAB” which stands for “you need a budget” with its own fan club and software. I’m here to tell you that traditional budgets are near worthless.
Author: Robert A Felberg MD
Topic: Physician Finance
Keywords: Financial Independence, Budgeting, Personal Finance
Nearly all financial experts will tell you that the must do is “have a budget” and “stick to it”. It is such common advice, that it’s almost never challenged. It reminds me of the dogma of my medical school days, where I was taught “Insulin makes the sugar go down” and when the patients ended up in the morgue that “it was the patients fault for not taking more insulin and eating less sugar”. Of course, no one realized that diabetics died mostly from stroke and heart disease and that the commonly advised treatment plan for diabetes was, in the end, essentially ineffectual.
Budgeting, the concept that you predetermine spending for certain categories, and then only spend up to that amount and not a penny more, is a disaster. Budgets are almost never successful. As a matter of fact, budgeting is such a poor option that most people never even bother to develop one. And those that do develop a budget, rarely stick with it for more than a few months. The funny thing is, the most financially savvy people don’t budget. Not in the traditional sense. So why are we wasting our time beating people up over a tool that doesn’t pass the real-world utility test?
Editor: There is a lot of great physician financial advice out there in the “blog-o-sphere”, but much of it is highly technical and doesn’t really address core understanding. This leads to decision paralysis. In this highly popular series, I discuss physician financial planning from a pragmatic and less technical standpoint. In the first part, the need to consider your future role as a physician is discussed. In the second part, the role of net worth rather than salary explains why so many physicians are financially strapped. The third part of the series addressed how much you actually need to save to reach your financial goals. Please sign up for our newsletter and follow our blog for future installments
How is it that the most financially successful individuals get by without a budget? The answer is deceptively simple. Budgets don’t work, and they are typically harmful. No one can predict how much they will need to spend on cleaning supplies next October. And the concept of a budget is to deny yourself and then feel guilty when you overspend on an extra hotdog at the ball game. Eventually, you consciously or sub-consciously decide that you don’t need more guilt in your life, and you dump the budget (or never start). Here’s where you run into danger- over spending is a financial killer! You need something to replace the traditional budget while reducing overspending at the same time.
Here’s the good news, there is a long-term budget replacement that is far more effective. It has several names- Zero Based Budgeting, spending tracking, balancing or reconciling your budget, a money date, family financial meeting, and others. Whatever you call it, the concept is straight-forward. You
meet with your “stakeholders”- spouse, adult children, or just yourself. You collect and review the following
- Incoming assets
- A family, in many ways is like a business. You have incoming assets or money. You also spend on locations, goods and services. The first step of your monthly review is determining how much income you brought in from any sources.
- Pretax vehicles and accounts
- These are the accounts like a 401k, 403b, 457b, or Sep-IRA that are filled with pretax dollars. Your goal, of course if to maximize these accounts.
- Non- discretionary spending
- Everyone has expenses that are “fixed” (or are they?). These include rent, mortgage, electricity, cable, cell phone service, etc.
- Discretionary spending
- This is the money you spend and have some control over. It is important that you have a way to track all your spending including cash that you withdraw from an ATM and blow on coffee. Typically, this is where your low-hanging fruit will be located. Your credit card spending will be included here as well.
- Checking and emergency funds allocations
- You need to keep a certain amount in your checking for day to day spending. You also need to maintain an emergency fund to avoid going into expensive debt. Editor note: emergency funds will be addressed in part five of this series. Sign up for the newsletter to be kept up to date
- Remaining assets for investment
- This is the fun part! And why this method is better than budgeting! Budgets are all about beating yourself up over spending. This method is about the joy of putting your hard work to use. Any left-over assets are “swept” into investments, debt repayment, or planned luxury spending. Editor: part six of this series will open the topic of debt repayment and allocation for this amount. This is a contentious issue that I hope to resolve over several posts, so stay tuned.
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How does the meeting work? You pick a day, usually at the end of the month. You meet with your family or just set time aside for yourself. Some people plan a “money date” where they go out on a fun romp and meet. That’s up to you. Seems like a good way to ruin a dinner by discussing ways to cut spending while indulging…
At the meeting you do the following:
Before you start, I advise that you review the purpose of the meeting with all those present. The reason you are meeting to develop and implement an ongoing plan to reach your financial dreams. State what those dreams are- travel, a boat, early retirement, a second home. Get everyone on the same page. Try to set the mood that current sacrifice will pay off handily. Try to get everyone to think cooperatively. You want to avoid a “blame-fest” when you review the monthly financial statement.
1. Address incoming assets. Go over in detail where the money is coming from and ways to earn more. Remember, for a physician, earning more is always easier than saving more. Just work another shift or take on some locums. Is it wise for one spouse to stop working altogether? Keep in mind that diversity of income sources is also important. Investigate passive income sources.
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2. Go over pretax investments. Have you maxed all the vehicles available? Why not? Since you know from part three of this series that you need to save 18%-40% of your pretax income. These accounts are ideal for this type of savings. You have a strong justification to make this your highest priority
3. Review your non-discretionary spending. Some of this spending is relatively untouchable- mortgage, life and homeowner’s insurance, taxes. Other may be more “discretionary” than you believe. That Mercedes you are leasing could easily be replaced by a used model. The cable bill can be cut for hundreds of savings. Go over everything, including insurance and mortgage options, and look for opportunities to save. Maybe you can refinance your mortgage or shop around for car insurance.
4. Review your discretionary spending. This can get a bit cantankerous, so try to keep a team approach. Review spending in detail. Determine what items are luxuries and what were unneeded. Where can money be saved? Do you really need to eat out more than once a month? Do you really need that fifth pair of boots or those season tickets to the NHL? Maybe it’s time to use coupons while grocery shopping? Perhaps, you can buy some items in bulk? The more you drill down, the more you may be able to save. Over time, you will find this becomes second nature. You will start spending less, openly discussing purchases, thinking about whether certain items are truly worth the cost, and comparing prices and items to determine best value. You will also learn to budget, save, and pay cash for luxury spending rather than going into debt using a credit card for impulse purchases. Review and be certain you are not carrying balances on your credit cards. Watch over your bills for late fees.
5. Go over your checking account and emergency fund. You will need to take any remaining funds and top off your accounts to meet your pre-determined allocations. Don’t skip this important step. Improper management of your cash positions can lead to multiplying issues down the road.
6. Take any remaining money and invest it towards your future. This is where the financial meeting really shines. You don’t end the meeting yelling at each other over the cable bill or feeling guilty about the avocado toast you ate last week. Instead, you celebrate the money you have earned that you can use to reach your dreams! Come up with a predetermined plan on how you will allocate it. Maybe 10% will be saved for luxuries. 40% for debt elimination. 50% for investments. Congratulate yourselves. Talk about what this money means to you and your family. Maybe make a deal that when you save enough in the luxury fund you will go to Paris or Iceland. Calculate how many months you’ve shaved off the mortgage. You get the idea. Rather than dreading the sacrifices, get excited about saving money and building your financial future!
Put your budget in the trash. Start a new website called “YDNAB”- you don’t need a budget. When some expert tells you to start with a budget, tell them Cajun Bob says, “Budgets are for chumps!’
Instead, have a financial planning meeting monthly. At first it will feel awkward, but you’ll grow into it. In six months, you’ll have a true understanding of where your money is coming from, where it is going, and how you can build on the future. And that’s a valuable outcome.
Cajun Bob’s Bonus round: The best way to save more is to earn more. You’ll need to negotiate to get what you are worth. Start with a market value report and then up your skills with a one-on-one skype session. Don’t make the number one doctor mistake– ignoring negotiation as your most vital step in your financial future
So, what do you think? Do you have a traditional budget and stick to it? Have you ever tried a financial meeting? Do you have the courage to go through your discretionary spending in detail? Do you have a plan to invest your hard-earned cash? Let me know in the comments below.