Budget Giving You Trouble? Look Below the Surface

If budgeting were easy, you wouldn’t be reading this. It’s not easy. You may already know not to overspend, and you understand income minus spending equals savings. That’s not the problem for many people who struggle with budgeting. The hard part is accidental under-planning.

If you’ve ever made up a spending plan that only worked for a month or two, you have probably experienced the effects of under planning. The typical budget format includes monthly expenses like housing, bills, transportation, and food. You also include non-monthly spending like clothing, vacations, and car maintenance. If everything on your spending plan adds up to your income but you didn’t actually plan for everything, you will overspend.

Under-Planning Leads to Overspending

The hardest part about budgeting may be planning for future expenses. These are the expenses that we know will happen. We know they’ll subtract from our income. But we don’t know exactly when or how much. Like the submerged part of an iceberg, we know it’s there, but it’s difficult to see how deep it really goes.

Since stuff doesn’t last forever, you can’t budget as if it will. For example, I know my computer won’t last forever, neither will my mattress, or my car. These are just a few of the dozens of similar expenses I’ll repeatedly face throughout my life. I don’t know when or exactly how much each of these will be, but I also know I can’t just ignore them. Therefore, I had to adopt a method to plan for them so I wouldn’t overcommit my income to other things.

It’s not just big-ticket items either. The little things add up. We know that, but it’s easy to brush many of them of as too-small to worry about. It’s easy to assume you can find the money for a new toaster oven, concert tickets and parking, or replacing your printer ink when those happen. But that money keeps getting diverted from other expenses. If you know that tiny slices of your income will inevitably be spent on little things, why wouldn’t you want to try to include them in a spending plan?

Budgets are Icebergs

Icebergs can sink ships, and irregular expenses can sink spending plans. The visible portion is deceptively small, and the danger lies below the surface. Your regular monthly expenditures are the tip of the iceberg, but irregular expenses are often hidden well below the surface. If you want to effectively navigate around them you’ll need to estimate their size and even reevaluate those estimates as you get closer.

Budgeting, like navigating across a sea full of icebergs, is a skill. You must give some budget items a wide berth. Sure, you could get closer but at the risk of damaging your ship. So you have to guess at the edges, striking a balance of not getting too close and not going too far out of your way. This skill improves with practice, and it gets easier and more accurate over time. But you’ll need to adopt some basic techniques to get started.

Use Placeholders to Get Close

It’s necessary to reserve income for irregular expense, but it’s not necessary to predict the actual amounts. You can’t nail it. Life is too uncertain. The goal should be to get close, so you can minimize the impact to your spending plan. As the expense approaches you can fine tune, but If you use reasonable methods to prepare for these expenses now, you can use placeholders in your spending plan.

There are many ways to estimate future expenses for your placeholders, but here are a few techniques for some of the harder to plan expenses that you can adopt. Remember, these are not techniques to project future expenses. These are ways to decide how much of your income, today, shouldn’t be allocated to regular monthly expenses. It’s the amount that, if reserved in a savings account, will be available to help meet irregular expenses.

Vehicle Maintenance and Replacement

The parts of a car don’t last as long as the car itself. Oil, bulbs, wipers, tires, brakes, batteries, entire mechanical or electrical systems, will eventually wear out and need replacement as will the car itself. An easy way to budget for maintenance and replacement is to give yourself a monthly car payment, even if your car is new or under warranty. So how much should your car payment be?

The car payment should build up for your next vehicle, but it can also be used for maintenance on your current vehicle. Since the more you drive, the more wear and tear you put on your car, it’s a good idea to tie the size of your car payment to how much you drive. You could use mileage, but I prefer to use gas costs. A good car payment is twice as much as your average monthly gas cost. And it works with one car or multiple cars.

Here’s an example. If you spend $300 per month to fuel your vehicles, you could use $600 as your vehicle maintenance and replacement monthly expense. That money will accumulate, ideally in a high-yielding savings account. You use it for maintenance expenses, but the rest builds up for when you have to replace a car.

Home Maintenance

Like a car, parts of a home don’t last as long as the home itself. But unlike a car, a well maintained home can maintain it’s value and last a lifetime. Since more expensive homes are usually more expensive to maintain, budgeting for maintenance based on the value of the home is a popular method for creating a spending placeholder.

Also, like car maintenance funds, the money reserved for home maintenance will build up to cover the less frequent, higher cost items like new flooring, roofing, windows, kitchen countertops, etc. Homeowners may spend 1% to 3% of a home’s value per year, on average, just to maintain it. That may seem like a lot, and most years, the cost will be less. But significantly higher costs every few years can easily average out in that range. Start with a percentage of home value and divide by 12 to determine the amount of monthly income to reserve for spending on home maintenance.

If you live in a condominium, you might use 1% of the home’s value as a place holder. That, plus homeowners’ association fees should come pretty close for maintaining both the inside and outside of your home, but you may need to increase that if you are also responsible for any exterior maintenance. If you live in a single-family, detached house, 2% is a good placeholder unless you also have a swimming pool. Maintaining that pool will be easier if you reserve 3% annually for home maintenance, which includes the pool.

Personal Property Maintenance and Replacement

While homes and vehicles can be costly to maintain, all the other things you own could add up to a cost just as big or even bigger. Clothing, furniture, electronics, kitchenware, linens, and many other items can seem insignificant on an individual basis, but some households may spend almost 10% of their income on personal property.

For some, clothing alone could easily be close to 5% of the budget. If you have a sense of how much your average spending on clothing will be, you can calculate that separately and then plan for 4% to 5% of your income to be reserved for all your other personal property. Much like a home or a car, typical monthly spending on personal property will likely be less, but continue to reserve the additional funds for when the bigger ticket costs come up.

Reserve Those Funds

Reserving money for irregular expenses means you’re not allocating those same dollars to something else. But the nature of irregular expenditures means that you won’t spend it all every month. Continue to reserve it. Use a separate savings account or several accounts if that makes it easier to manage. Nickname the accounts to help remember what it’s there for. Set up regular transfers to fund them, and when you have maintenance expenses, reimburse yourself from the savings account.

Remember, the idea of using placeholders, it to get you close. You will still need to maintain a fair amount of flexibility in your typical monthly spending should you need a little more money than planned. Ideally, these placeholder guidelines will be a little more than necessary, providing you with a small cushion, just incase that perfect storm of multiple maintenance and replacement expenses hitting at the same time.

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Author: Dylan

Dylan Ross, CFP®, AFC®, is the Director of Communications and Financial Planning for the Garrett Planning Network. He became a financial advisor in 2000 and has been writing about personal finance since 2005. Follow him on Twitter @SemperFrugalis.