Everyone aspires to having enough wealth to live worry free. Just how much you need depends on your personal definition of what is enough. Usually growing wealth isn’t possible without some type of spending and savings plan, or a budget. Budgeting is the process of managing your income, expenses and savings to maintain financial health. Now whether it is followed intuitively or actively tracked, having a thoughtful budget is a prerequisite for ensuring you always have enough to live a fulfilled life.
Where Short-term Cash Management Falls Short
Budgeting can be tricky with many moving parts and the resulting spending and savings plan is often incomplete. It is common to become focused on fulfilling your immediate needs and wants from month-to-month. With so much competition for our attention, it is easy to get caught up in the moment. As a result, our ideas about spending extend beyond a few months infrequently, often when presented with the unforeseen expense.
For most people, cash management is murky, making it difficult to anticipate and prepare for seasonal or uncertain expenses. Most people use one account where all money comes in and all money goes out: the bank checking account. Organizing multiple spending and savings goals for both your current self and what you imagine your life to be someday may feel impossible, keeping you stuck in a cycle of month-to-month cash management. Spending your take-home without consideration of both short and long-term goals can jeopardize your ability to build wealth needed to achieve financial independence.
Too Little Cash
For individuals who are struggling to make ends meet or are cash poor, it is often necessary to take out loans or go into credit card debt to manage their daily expenses. This can lead to long-term financial challenges or catastrophes, depending on the cost of the debt, how long it is maintained, and how much debt is acquired.
Too Much Cash
Some people find themselves with more money coming in than going out. Holding on to excess cash poses different financial risks if the cash isn’t being reallocated to long-term savings that correspond with their long-term goals. Cash that accumulates into a typical bank savings account over long periods is effectively losing money. According to the FDIC, the national average interest rate on savings accounts stands at 0.46% APY (as of February 2024), while inflation, or the decline in purchasing power, goes up on average 3.15% annually, with recent inflation averaging 6.04%.
Living on the Edge – No cash and Insufficient Savings
Many people fall somewhere in the middle, spending most or all of their income that comes into their checking; neither accumulating nor going into debt. This is ideal if enough income has already been appropriately saved toward long-term goals, like retirement, owning a home, or education accounts. This situation may feel pretty good in the present, but if you haven’t considered your long-term savings plan, this strategy is at risk of falling short of your retirement expectations.
Even if you are due to receive a guaranteed income, such as a State of Alaska pension or social security, or are making your mandatory employee contribution to your Defined Contribution plan, there is a good chance that these income sources alone aren’t enough to sustain the lifestyle – or expenses – that your life demands when you are ready to retire.
Instead Take A Big Picture Approach
Research has shown[1], [2], [3], [4] that increased savings is tied to our ability to imagine our lives at ages out into the future. For the uninitiated dreamer or preoccupied doer, creating a vision for the future might be an unfamiliar idea.
Short-term Goals
Funding short-term financial goals quickly comes to mind when managing cash. In addition to covering immediate monthly expenses, short-term goals are also things you will spend money on within a few months or years. A few examples of short-term goals include an emergency fund, bills & utilities, travel, paying down loans and credit cards, or home improvement.
Long-term Goals
Long-term financial goals are big picture items that may take many years or decades to accomplish. Long-term goals might be a retirement fund, paying off a mortgage, or funding a child’s college. Setting money aside for long-term goals has the effect of reducing cash available for short-term goals, requiring more careful budgeting.
Manage You Cash For Lifelong Success
Set yourself up for success by creating a plan to grow your wealth by considering goals over many time frames, from a month out to decades away. Follow this process:
- Identify different types of expenses and savings – Are they a need or want?
- Prioritize goals for different durations.
- Balance needs for both short and long-term goals.
- Recognize what are your core-value wants over everyday desires or ingrained habits
- Balance your budget around the prioritized needs and wants.
- Review, revise and repeat as life changes.
Need or Want?
The highest priority goals are necessities. Needs are the things you can’t get by without, such as a place to live and food to eat. Wants make your life richer, but they are ultimately things that are nice to have but not absolutely necessary, such as entertainment or dining out. As you prioritize your goals, prepare yourself to think critically about your needs and wants. Is that new boat a need, or is it actually a want? Is it a core-value want or just something that would be nice to have but you could really live without? If your budget falls short, it will be important to differentiate between needs and wants.
How to Prioritize Short and Long-term Need-Based Goals
Identify short-term goal needs first. Many will occur monthly such as paying for utilities, personal goods, making a mortgage payment, paying down debt, or trickling cash into an emergency fund. Others happen periodically or seasonally throughout the year, such as paying for annual property taxes, medical expenses, or heating oil delivery.
Since everyone should have one, start with an emergency fund. This fund should be kept and used for unexpected expenses or job loss, preventing you from having to dip into savings for designated goals or going into credit card debt. They typically consist of 3-6 months’ worth of living expenses. Consider making regular monthly savings to this fund so it is always replenished. Keep in mind Alaska tends to have a higher cost of living compared to many other states and unexpected expenses can cut into your budget more severely than if you live in other states.
Next, expand your time-frame out a few years. Ask yourself what things need to be maintained or replaced in your life in the next 5-10 years. I swear, everyone hates the dreaded, “where do you imagine you’ll be in 5 years” question, but when it comes to budgeting its worth the exercise to avoid ‘unexpected expenses’. These expenses might include a car, furnace, appliance, or a new computer.
Expand your vision further into the future yet. What does your future self need in 10, 20, or 40 years? This older version of yourself will need an income, house over their head, and food to eat at a minimum. Take time to imagine what that looks like for you. If you can clearly envision your future self, you are much more likely to save for the future you imagine.
Wants Follow Needs
Your wants are discretionary, but some are more important than others. Inventory your discretionary spending habits and determine which are not negotiable in order to be living your best life. These are expenses that are essential to your well-being and happiness. They reflect you and your family’s core values. Core values are your root beliefs, what makes you who you are, and why you see the world the way you do.
Identify which wants reflect your core-value or are essential to living a fulfilled life and prioritize these over other wants. Common core-value spending categories I’ve encountered, not in any particular order, include travel, giving, faith, gear and equipment for experiencing nature, maintaining relationships (special shopping, special events), or home improvements. As you imagine what life with the essentials looks like, ask yourself how much of your remaining income would need to go to these core-value goals over everyday conveniences.
Day-to-Day Spending
All remaining discretionary expenses could be funded directly from your checking account, mingled with mandatory expenses. These expenses are negotiable and should fit within the remaining unbudgeted allowance.
Use credit card and checking account spending histories to help you estimate how much you might expect to spend within broad categories, such as shopping, family and pet care, dining out, or entertainment. If certain areas consume significantly larger parts of your budget than others, look into these expenses more carefully. If you discover you aren’t able to live within your budgeted expenses and savings, hire a financial coach, financial counselor or financial adviser, to help you identify spending challenges and opportunities so that you can get your short-term expenses aligned with long-term goals.
Budget Your Way To Wealth
Once you’ve figured out how much money you can spend on short-term needs and wants, and long-term dreams and necessities, you can set up monthly savings to long-term goal accounts, like 401ks or education savings accounts. Consider organizing your short-term and some long-term goals using digital envelopes, or buckets, and work toward them. Use a 50/30/20 budget calculator to get you started.
There are many resources to help you dive deeper into budgeting if you are ready to start building wealth:
- Schedule a call with Frontier Financial Planning to learn more about using a single balance sheet with banking buckets.
- Try budgeting software.
- Hire a Financial Coach or counselor.
A budget is the foundation of a financially successful life. With these building blocks in place, you will be able to put yourself into a position to grow enough wealth to live the life you can only begin to imagine.