BUDGETING

How to Solve the #1 Reason for Budget Failure

By Pamela Horack, CFP^®

Budgeting is a struggle. In an effort to tackle this basic financial skill, my team at SMART Budgeting surveyed advisors to find what works and what doesn’t — for advisors and, more importantly, for clients.

The number one response to a question about why client budgets fail was: Tracking is overwhelming. Let’s review why tracking is so difficult and how we can fix it.

What’s Wrong with Tracking

Advisors who help clients budget need to know what they are spending and where the money is going.

Most people have not been taught how to create a budget. Any approach to budgeting was likely addressed as a math problem that went like this: List your income, subtract your expenses, and hopefully, you end up with zero or a positive number.

Then, there is additional guidance. Pay yourself first. Separate your fixed and variable spending. Use the 50/30/20 rule. Use the envelope system and spend cash. And track your expenses.

The challenge is that life is not a math problem to be solved but an experience to be had. Everyone is on a different journey, and money should support the adventure. When the math becomes disconnected from the experience, budgeting becomes a futile effort.

Expense tracking is hampered by the variety of methods we use to pay for things. We still use cash and checks but debit cards and credit cards are the norm. We have ACH charges and other debits for payments, as well as online bill-pay solutions. Expense tracking needs to be able to account for all types of transactions.

The advisors in our survey who help clients budget said they used bank and credit card statements, account aggregation, planning software, and spreadsheets to help track information. These methods neglected cash transactions.

Software and apps — whether geared toward advisors or clients — are often complex and difficult for both advisors and clients to use. Aside from the initial setup and maybe a monthly fee, there are too many distractions in the real world for people to maintain the expense tracking they need. People generally don’t have the patience to use elaborate solutions for the length of time needed to build new budgeting habits.

An alternative solution — putting the numbers on paper — is a lot of work. Even when people manage to get their numbers right, breakdowns occur with implementation. People say, “OK, I have a budget,” and then they continue spending exactly as they did before they listed their numbers.

Tracking can actually be demoralizing. For example, let’s say an individual’s grocery budget is $800 for the month. When they track and compare numbers, they find they have spent $950. When this happens time and again, they begin to feel like a failure. Failing to meet the mark translates into the feeling of not being good enough. When people can’t meet their budget numbers, they decide tracking is not worth the emotional pain, so they just quit.

Tracking the Right Thing

While there is no best way to track expenses, almost all survey respondents wanted some type of monitoring to help clients keep on track. But how?

To track budgets effectively, we need to change the benchmark. We have been tracking the wrong thing. Instead of tracking spending categories, we need to measure progress toward achieving the client’s values and goals.

First, clients need to understand what they value in life. A great exercise is the Values Exercise from Think2Perform. Having couples collectively decide what is important to them will allow them to set spending decisions that align with how they want to live.

Next, based on their values, clients need to develop SMART goals that are Specific, Measurable, Achievable, Relevant, and Time-based. Doing this allows them to set savings numbers for near-term and long-term goals. These goals should correspond with their values.

Now, the client can decide how much to save, and they can determine their fixed expenses for the month. Clients should also determine how much they generally use for discretionary spending.

With this information, we are ready to do the math. Our formula should be: Income minus savings for goals minus fixed expenses equals discretionary spending.

If the client’s math is off — and in my experience it usually is — they need to make adjustments. If income is greater than expenses, they should review their numbers to see if they want to save more and reach their goals sooner. Then, they should review fixed expenses to see if they can pay down debt faster. Finally, any remaining funds can go to discretionary spending.

If the client’s expenses are greater than their income—which is often the case—they need to work backward. First, they should cut any non-essential discretionary spending. Next, they need to review their fixed expenses for reduction opportunities. Finally, they may need to reduce their savings and realize their goals may take longer to achieve.

Now that the client’s budget is aligned with their values and goals, we can help them reset their tracking measurements.

To do this, clients need two checking accounts. The first one, which I call the main checking account, is used exclusively for income, savings, and fixed expenses. The second one is specifically for discretionary spending.

Clients can set up automatic deposits, regular savings, and automated bill payments for the main checking account. Once the transactions are automated, the numbers are established and do not fluctuate much. This account effectively manages the client’s core needs with little ongoing maintenance.

Now, the discretionary checking account can be used for every other day-to-day expense. Whether the client is going to the grocery store, shopping on Amazon, picking up dry cleaning, or making a cash withdrawal, they can spend any amount they want from this account. They no longer need to categorize and track each expense.

Client spending can now be effectively managed by making sure their balance does not go below zero. For clients who can afford to carry a larger balance, this is easily regulated. Clients who run low toward the end of the month might want to set a Low Balance Alert when their balance gets to a set number, let’s say $300. This reminder allows the client to realize they have a finite amount of money to spend until their next payday. This scarcity forces decisions that differ from those they’d make without an awareness of their limited budget.

For example, the client needs to go to the grocery store and buy gas for the car. They have only $150 in their discretionary checking until payday. They will have to decide how much they are willing to spend on groceries and on gas. Or do they even need both right now?

Aligning the client’s spending with their values and goals allows them to focus on the things that are most important in their lives. Establishing multiple accounts helps them adjust their lifestyle spending and removes the stumbling block of tracking. Using a main checking account to distribute savings and fixed bills gives them the security that they can maintain their current lifestyle. A second checking account with a smaller bucket of money allows them to use scarcity to manage daily expenses and solve the tracking dilemma.

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Pamela Horack, CFP^®, is Your Financial Mom at Pathfinder Planning LLC and SMART Budgeting App for Advisors. She uses her “Mom” style to coach clients with their budgets and financial plans. She can be reached at pam@pathfinderplanningllc.com. 

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