What Goes Into a Monthly Spending Plan? What Stays Out?

In my financial coaching practice, my clients and I spend a good amount of time crafting, honing, and perfecting their monthly spending plan. The time spent on this part of a financial plan is mission-critical for overall success. It is not a “set it and forget it” plan as it takes time to get it right and find a tracking system that works.  It is fluid, meaning it is always evolving when life changes, and it must be tracked on a monthly basis for it to be successful. The spending plan (some people call this a budget, but I don’t like that word) is a tool that people often get frustrated with and give up because they can’t seem to make it work. One of the biggest issues my clients have is knowing what to put in their monthly spending and how to accommodate for one-off expenses that are not regular monthly expenses. I will address what goes in a monthly spending plan and what stays out. 

In order to begin your monthly spending plan, you have to get clear on monthly income first. If you have a W2 and make consistent monthly income, this is a snap. But, if your income varies from one month to the next, you will need to come up with a 6- to 12-month average. Determine your monthly income and maybe come up with a few ideas for increasing it down the road. 

I’d like you to start listing expenses out next. I want you to group them into three main categories: mandatory, discretionary and savings. If this is your first time really looking at how you spend your money and categorizing, I want you to look at the last 12 months of spending. Yes, this is a commitment in time. It is time worth spending as this is the best way to get complete clarity on your habits and to ensure you are creating a spending plan based in reality. If you can see there are categories that you spend in every month, they will go in your monthly spending plan. IMPORTANT: If they do not happen monthly, but sporadically, I want you to put a note by them titled “short-term savings”. 

After you have categorized your spending, you now can provide a monthly average for each category. We will use this average when building our monthly spending plan. 

Now I want to talk about the categories and why they are important. There is a popular budgeting framework called the 50/30/20 rule. This suggests that a smart spending plan allows for 50% of income to be spent on mandatory expenses, 30% on discretionary items, and the remaining 20% is put toward saving for the future. I challenge you and all my clients to first start with the 20% savings. Fund this first. So, take 20% of your monthly income and make sure it’s going to savings. If you have a 401k plan at work and you save 5% and your employer matches 1%, you already have 6% done. Congrats! The goal is to have at least 10% of your income going toward long-term savings goals, like retirement, and the other 10% going toward short-term savings (money that will be spent within 1-3 years). Paying yourself first and making sure you are setting aside 20% of your income is the #1 tool for getting you on the path to building wealth. Without it, you are living paycheck to paycheck, beyond your means, and setting yourself up to have bad debt. Pay yourself first and get out of this cycle. 

The mandatory expenses come next. If we are using the 50/30/20 framework, you should challenge yourself to keep these expenses to no more than 50% of your monthly income. Mandatory expenses are the items you spend on for your basic living needs. These are  housing, transportation, medical, food, utilities, insurance, cell phone, daycare, and basic clothing needs. If you don’t need it to live, it belongs in discretionary spending. If you find you are spending well over 50% on mandatory expenses, this will pinch the next category, discretionary expenses. Or, you can take a long hard look at what you are spending on mandatory expenses and perhaps there are ways to trim it down. Being house poor and having no discretionary spending is not fun. Most people cancel out the 20% savings, and this is what sets us up for financial failure. Trim the fat in mandatory spending so you can have every category funded appropriately for a balanced life. 

What’s left after setting aside money for savings and mandatory expenses is your discretionary spending category. If you are spending more than 30% of your income in this category, you have some work to do on your spending habits. Chances are you are not saving enough and possibly having a tough time paying your bills on time. Having control over discretionary spending is the make-or-break piece of a spending plan. If you are spending money you haven’t yet earned on things you don’t need to impress people you don’t even like, you need to stop this. We all want and crave discretionary items, that’s natural. I just suggest you comb it all down to the things that are really important to you and your family. Keep it to 30% of your income and set yourself up for success. 

At the end of this exercise, your total combined expenses should net as close to zero against your income as possible without going into the negative. Put every penny to work, give it a job, and be in control of your money. I always keep $500 in my bank account at the beginning of the year to accommodate for cashflow. Then, at the end of the year, after all expenses have been paid, if there is more than $500 in my checking account, I get to spend the extra funds any way I want to. It’s like finding money in a jacket you haven’t worn in a while. Have fun with it. 

So what about that “short-term savings” note I had you write down by expenses that aren’t being spent every month? These items stay out of your monthly spending plan and instead are accounted for in your savings category. Add them up, divide them by 12, and this is the monthly amount I want you to put in a short-term savings account. These are expenses that pop up throughout the year and if not planned for accordingly, tend to wind up on the credit card balance. These items are usually for vacation, car maintenance, house upkeep, taxes, medical, vet, gifts, insurance (if you don’t pay monthly), sports & hobby equipment/lessons/teams/camps, etc. Set up a separate spreadsheet to keep track of the money you put into short-term savings and assign a money bucket to each of these categories. Track when money goes in and when money comes out. This is how you make sure these things are funded and you are not paying for them with debt and being charged interest. Remember, you should have an emergency category in this short-term savings account and it should hold 3-6 months of mandatory expenses. If you don’t have this set up, fund this money bucket with the 10% you are setting aside additionally in short-term savings. 

So now you know what goes into a successful monthly spending plan. And, just as importantly, you know what stays out of your monthly plan and gets accounted for in short-term savings. If you have questions and want to get some further direction on this spending plan system, I invite you to join us for Friday, Friends & Finance by clicking here. It’s a free monthly coaching session and we discuss the details of my monthly article. You may also schedule your free Q&A by accessing my calendar here. As always, be confident and in control of your finances and I look forward to hearing from you.