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Why You Should #DoTheMath

Why You Should #DoTheMath

March 22, 2024

Cash flow. Funds. Finances. Balance Sheet. Nest Egg. Slush Fund. There are a lot of different ways to describe budgeting. When faced with the word “budget” itself, many of us become overwhelmed or anxious at the prospect of looking closely at our money and where it goes. But it doesn’t have to be a daunting or scary process.

Simply put, a budget is just an estimate of your income and expenses over time. It can be as simple or as complicated as your specific needs require it to be. However, the anxiety that some may feel at the thought of creating a budget can lead to the questions “Why bother?” and “Is there really a benefit to budgeting?”

Some of us may think “I’m not in debt so I don’t need to worry about my spending” or “I have enough at the end of the month; I don’t need to count every penny.” But a budget is more than a tool to keep your head above water. It’s an asset that can help you plan your future – whether it’s a life changing event like marriage or retirement, or something smaller like that vacation you’ve been dreaming about taking. Budgeting can also ensure that you have enough saved for those unexpected expenses life likes to throw at us from time to time.

A lot of financial planning done these days is goal based rather than cash flow based, which might sound like the right way to prepare. But unfortunately, goal-based planning isn’t as accurate, and your financial plan may still fail you in your retirement years. Nobody wants that. Which is why cash flow-based planning is a much more reliable way to go. So, while creating and using a budget or cash flow may seem like a chore or a challenge now, it will be a cause for celebration in the future!

HABITS AND OVERSPENDING

By seeing your money coming in and going out, you can map out your goals so your budget becomes your personal financial GPS. It makes saving easier as it offers a way to see and track spending habits you might not have known you have and can keep you from long-term overspending. We’ve all gone over budget at one time or another, but it’s a habit that can be hard to break once it starts, especially in this world of credit. And when we get into overspending, now we’re not only in financial territory, but psychological as well.

There are many reasons why we overspend. These include everything from inflation increases on necessary items to societal pressures or “Keeping Up with The Jonses.” People tend to equate material purchases with a sense of self-worth or social status.[i] Even if, in obtaining that perceived status, they are now living beyond their means. When neighbors buy new cars or perform costly home remodels, it can be tempting to want to experience that same thrill of something new. The habit of comparison and the psychological idea that the grass is greener on the other side can lead to major purchases that don’t fit into the well-balanced budget. And we rarely give up things in other areas to offset the big expenses. By looking at overspending habits revealed by a budget, we can identify the “Keeping Up with The Jonses” purchases and see just how much impact they really have not only on your monthly expenses but your overall financial health. 

Overspending habits don’t always show up on a budget as big-ticket items. What about impulse buying or retail therapy? It can feel great in the moment to buy something that gives our brains a serotonin boost, and we can easily justify it; “it’s been a hard week, so I deserve this.” But people tend to use retail therapy or impulse buying as an outlet to feel control when they’re not necessarily in control of the outcomes in their lives.[ii]Much like with “Keeping Up with the Jonses,” retail therapy serves as a catalyst to temporarily improve a person’s feeling of self-worth while it’s ultimately developing into habitual overspending. By understanding the emotional aspects of overspending and keeping a budget that you can stick to, you can develop healthier alternative choices that don’t cause your bank account to take a hit or overuse your credit cards.

Speaking of which, credit card debt has become a major problem for consumers over the last twenty years. According to credit bureau TransUnion, the average credit card debt per borrower rose to $6,088 by the third quarter of 2023.[iii]  And that comes with higher interest rates compounding the debt month after month. The ease of paying by credit card is both a blessing and a curse. Being able to just tap or swipe and have your purchase complete is a major convenience. But it’s hard to see those dollars adding up with every purchase. By accounting for credit card purchases in your budget, or allocating a set amount you can use on your card per month, you can help not only keep yourself from dealing with high interest payments but also plan for ways to get out of debt if you’re experiencing it.

 

LIFESTYLE CREEP

We live in a society where wants and needs are often treated as synonymous. We convince ourselves that we need to spend more to enjoy more. Maybe this sounds like someone you know; “I’ve worked hard all my life and now is my time to enjoy the fruits of my labor.”  Or perhaps you’ve seen people explain their spending choices by saying, “we want to make the most of our early years in retirement while we’re still healthy.” It’s understandable to think these things, and to want to experience “bucket list” dreams and desires while they can. But this kind of spending doesn’t consider the kind of living these folks want to be doing after they’ve spent the bulk of their retirement savings. What happens when the 67-year-old retiree spends 40% of their savings in the first 5 years of retirement and lives another 30 years with increasing medical needs.

Whether you retire with millions or a few hundred thousand dollars, the scenario is true for all of us. You could outlive your money if you don’t plan ahead and stick to the plan. If you spend too much in your early retirement years, it could cause a strain in later years if you experience a major health event, nursing care needs, or even a major financial expense for your home or your family.

Being realistic when it comes to those “want” expenses both now and in the future will really help with your budget and planning. How much will you really need to spend on your eventual home remodel, for your vacations (two per year? three?), for your entertainment and recreation. Don’t sell yourself short. You should be enjoying your retirement. Just budget for it so you know how much you’ll need.

One other thing to consider is your insurance coverage. It can be tempting to choose policies with the lowest premiums to save money, but those budget policies tend to come with minimal coverage, which can mean disaster to your budget and savings in the event of an unexpected accident. It’s not worth it to be penny wise and pound foolish. You can be protected, have your wants, and cover your needs, too, with a budget and a plan. This way you can avoid the creep and have the lifestyle you want for as long as you’re here.

UNEXPECTED EXPENSES / EMERGENCY FUND

Many people live right down to the penny monthly. This is especially true for retirees counting on their social security and investment distributions. Unfortunately, this leaves too many of us without any safety net for unexpected expenses or emergencies, like unforeseen home repairs or medical costs, an emergency vet bill, job loss, or car repairs. Generally, experts recommend setting aside 3 to 6 months’ worth of living expenses – including rent/mortgage, car payments, food, utilities, etc. in an emergency fund. [iv]

The best way to go about doing this is to create a separate account – like a money market or high interest savings account – and regularly put a set amount of money into it. Whether that is $10 a month or $100 a month. Another idea to consider is to throw any extra money you might get into your emergency account (such as a tax refund or birthday money) this can help boost the size of your emergency savings. This emergency fund is recommended to cover the costs of the unexpected and to avoid or mitigate the chance that you might have to withdraw from investments when asset values are down due to market fluctuations.

While you may not be prepared for the unexpected, you can be prepared to manage it financially, if you budget for your emergency fund and stick to the plan of keeping it funded.

We’ve talked about some of the reasons why budgeting and keeping track of your funds with a cash flow spreadsheet or list are important, but would you believe there are more! If you’re one of the few who have great spending habits, are disciplined about your expenses, and have that cushion of emergency fund savings, first of all – good for you! You may still think you’re all set and don’t need to budget. But there are still more reasons for you to #DoTheMath:

MEDICAL EXPENSES

One aspect of budgeting that can be challenging even for the most diligent, spreadsheet-loving, best of the budgeters is planning for medical costs. It’s hard when you’re young and healthy to think about setting aside money for your future medical expenses let alone determining how much to put in that bucket. You find yourself thinking about costs in today’s dollars for prescription drugs and insurance premiums. But what about future dollars? The percentage of U.S. GDP spent on healthcare increased to 17% in 2022.[v] This figure is set to continue rising in the future. Saving for healthcare based on today’s costs instead of what it could be in the future is one of the biggest missteps budgeters make, especially retirees, who think they’re financially prepared for retirement.  

One of the largest contributors to the rising cost of healthcare is the cost of long-term care for the growing number of people aged 65 and older. Experts predict that by 2032, 21% of the U.S. population will be over the age of 65.[vi] Long-term care isn’t just for nursing homes or in-home healthcare. People within this age group tend to have more chronic illnesses or require more expensive medical procedures, such as knee or hip replacements, heart bypass surgery, etc. Think of all the extra expenses that come with having to have knee surgery. Not only do you have to think of the costs for the surgery itself, but consultations with your doctors before the surgery and physical therapy and recovery after the knee is replaced. Insurance will most likely cover a good portion of those costs. But, making sure you have enough in reserve to cover copays or your deductible is very important. Creating a smart and strong budget that factors for the seeming unpredictability of future healthcare costs can help you better manage those hypothetical scenarios if they become reality.

This one can be tricky. If you find yourself needing help, you’re not alone. Seek out a budget-savvy friend, family member, or financial professional to help you so you don’t underestimate your budget.

LIFE EVENTS

Let’s talk about the big three… wedding, house, and baby. In 2023, it was estimated that the average wedding in the state of Michigan cost around $27,000.[vii]  Creating a wedding budget on top of your normal, personal budget, with all the financial contributors (future spouse, family members, etc.) is a great way to make sure your wedding day doesn’t bust your bank account. It’s also helpful to remember that a lot of couples tend to go over budget, so it’s wise to start your budget with money in reserve for some wiggle room. Just like lining up the florist, caterer, venue, and photographer in advance, having your budget set will help reduce your stress during and after your big day so you can relax and enjoy the special occasion.

Whether you’re buying on your own or with someone else, homeownership is a major decision for your life and your finances. Though the housing market is a moving target, the average price for a home in the United States was $416,100 in the second quarter of 2023.[viii]Buying a house is arguably the largest purchase you’ll make and comes with a lot of additional bills, some known… and some that surprise you when you don’t want to be surprised. Like the water heater going out on Monday morning or the air conditioner giving up in 90+ degree heat. Having a budget may just be the thing that keeps it all organized for you! But even if you set your mortgage and utilities to auto-pay and you pay your property taxes like any other monthly bill, it’s still a good idea to know just how much you’re spending and if there are ways to make your money work smarter by putting extra cash toward your mortgage payments, or monitoring your utility bills over time to see if you can reduce costs. The best way to keep track is to budget. And you may be surprised by what you discover by looking at all the costs associated with your home.

The birth of a child cost upwards of $18,000 in 2023.[ix] While health insurance can cover a large portion of the hospital bill, new parents still need to be able to pay their deductible or pay for costs their insurance won’t cover. Even though Michigan’s average out of pocket costs are lower than the national average at $949-1,026, it can still be a hefty sum to pay.[x]And what about all the other new expenses parents now need to account for like diapers, formula, clothes, and all the other new day-to-day expenses having a child creates? And the costs only grow as the new baby grows. Creating a budget to help save for daycare, school activities, and college funds will help both you and your children to have a healthy financial foothold.

RETIREMENT

Budgeting also helps you have a tangible grasp on building savings and investment contributions that help towards your retirement planning. Setting aside portions of your earnings each month to add to your IRAs, 401(k) or other retirement funds can lead to a sizable retirement plan. You can maximize your retirement contributions by taking advantage of employer matching contributions to employer provided 401(k)s.

“In some cases, it may seem like a good idea to add larger amounts to your retirement account, but if it means that the reduction in disposable income will result in rising credit card and other debts incurred for everyday expenses, then boosting retirement savings could actually have a negative effect on your bottom line.” [xi]

When planning your budget for your retirement, there are several important questions to consider and ask yourself. Consider what age you want to retire at or stop working full time and how that will affect your Social Security benefits. How and where do you want to live when you retire? Do you plan to downsize to a smaller home? Are you planning to stay where you are or move somewhere where the cost of living is different than where you are currently?

Experts advise making a “trial retirement budget” that includes day-to-day expenses, like housing costs and food, and health and long-term care in the city where you plan to retire. Roughly 70% of people aged 65 and older will need some type of long-term care during their lifetime and budgeting for that before it is needed will help ensure you have a comfortable safety net.[xii]Looking at a budget that includes those expenses and compare the money you plan to collect from Social Security, Pensions, IRAs, or any other income you would have coming. By doing the math, you can get a good sense of what you’d need to set aside for retirement.

 SO WHY BOTHER?

Knowing why it’s important to make and stick to a budget doesn’t necessarily answer the “why should I?” aspect of starting a budget. Maybe you already take advantage of your employer’s 401(k) matching program, maybe you’re able to pay off your cards each month, maybe you think all those big-ticket life events like weddings and childbirth are behind you. By your estimations, you’re doing fine financially. But budgeting can help you go from “doing fine” to “doing exceptional.”

So, knowing what you know now, are you ready to get started? If you are, we’re eager to help and our next blog post will be all about how to develop your budget and what important factors to consider when putting it all together.


[i] U.S. News and World Report. “Inside the Psychology of Overspending and How to Stop

[ii] Scott Rick, Beatrix Pereira, University of Michigan: Ross School of Business. “The Benefits of Retail Therapy: Making Purchase Decisions Reduces Residual Sadness.”

[iii] TransUnion. “Credit Balances on the Rise as Consumers Manage Higher Costs.”

[iv] Experian. “What is an Emergency Fund

[v] The Peter G. Peterson Foundation. “Why Are Americans Paying More for Healthcare

[vi] Ibid.

[vii] Bankrate. “Average Wedding Cost: Wedding Planning Tips in 2023.”

[viii] Motley Fool. “Average House Price by State in 2023

[ix] Forbes. “How Much Does It Cost To Have A Baby? 2023 Averages.”

[x] Ibid.

[xi] Investopedia. “What Are The 5 Purposes of Budgeting.”

[xii] CNBC. “Amid Economic Uncertainty, Here's How To Get Started With Investing and Budgeting.”