Putting First Things First. How to Budget Your Way to Success

People who are poor with money management and who end up at retirement without sufficient resources, despite having had a full successful career, put luxuries before necessary savings and investing.  Those who are truly bad at money management put things like cigarettes before necessities like food and rent.  Good money management is really fairly simple:  It is all a matter of putting priorities in order and funding higher priorities before lower priorities.  What you need now before what you’ll need later, and what you want after taking care of all needs.  It is also saving up for your wants since no one wants of needs to pay a bunch of money out in interest.

Here is my list of priorities.  When making a budget, I’d start at the top and then work my way down the list.  I make sure that items higher up are fully funded before I put any money to items lower on the list.  When I run out of money, I stop.  If I ran out before completing necessities, I’d find a way to earn more money to make sure at least all of my needs were covered.

SmallIvy’s Priority List:

No. Item Class Notes
1 Basic food and water Necessity Meals in, tap water
2 Basic clothing Necessity Nothing designer
3 Basic shelter Necessity Minimal needed
4 Basic utilities Necessity Just power, water, flip phone
5 Basic transportation Necessity A bike would do
6 Store of necessities Security An emergency fund ($9000)
7 Retirement Future need 15% of pay
8 Maintenance funds Debt avoidance Future home and car repairs
9 Replacement funds Debt avoidance Money for the next car, AC
10 College Funds Future need ESA or 529, >$2000/child/yr
11 Stocks and mutual funds Financial Security $300-$500/month
12 Donations Giving 10% of net increase
13 Meals Out Luxuries Monthly limit
14 Vacations Luxuries Yearly budget
15 Toys Luxuries Planned with spouse
16 Advanced Shelter Luxuries Upgrade home
17 Advanced clothing Luxuries Designer duds

 The basic needs (necessities) are shown at the top in light green.  These are food, shelter, clothing, utilities, and transportation.  Note these are at the minimum levels needed.  Food doesn’t mean eating out and shelter doesn’t mean a 3000 square foot home.  Those are luxuries.  It just means food from the grocery store (rice and beans if needed) and a basic living space (could be a 1-bedroom apartment or even a room in a home if I were single).

The sixth item is a store of necessities – basically saving up enough cash so that I could pay for necessities for a number of months.  I could store up physical goods (dried food, clothing, gasoline with a generator, etc…) but there is normally no need to actually have the physical items.  Just the cash needed to buy them should I lose my job.  Around $9000 is enough for this.  Once I have the emergency fund in place, I can start funding other things down the list so long as I don’t need to dip into the emergency fund.  If I do, then I will focus on putting money back into the emergency fund until it is built back up and then continue down the list.

Items 7-10 in dark green are important things that I will need to save for, because they are very expensive, but won’t come due for a number of years.  This includes huge things like retirement and college funds, but also smaller things like major home repairs and upgrades and replacement cars.  It seems like a long time off and it is easy to “live for today,” but if I get to retirement and I have no money I’ll be in a world of hurt, so I need to be saving regularly.    The home maintenance and replacement funds are labeled “debt avoidance” because if I don’t save for them I’ll probably need to take out a loan to buy the next car or replace the roof on the house.  Saving up cash so that I have plenty of money to pay for these things when the time comes allows me to avoid taking out a loan when these expenses come up.  This reduces the amount of money I’ll pay in interest, allowing me to get further down my list.  Note that because I’m not paying interest, it is easier to set aside money for future expenses.  Life is easier without debt – there’s no such thing as “easy credit.”

The items in blue are things I really don’t need to buy, but are things I want to have because they make life more pleasant. Item 11 in light blue, stocks and mutual funds, is the category that will let me increase my non-work income and get to the point where I can be financially independent, meaning that I no longer need to depend on a job to meet my needs.  It will take a number of years and a lot of hard work to get to that point, but if you put $300-$500 away a month into stocks and stock mutual funds, you should reach a million dollars somewhere in your forties or early fifties.  That would provide an income of somewhere between $40,000 and $60,000 per year beyond your work income.  This provides a great deal of security because you will know that you can meet at least your basic needs even without a job.  While you are still working it increases your income, which allows you to afford more luxuries.  Of course, you should also continue to redirect this money back into stocks since that will allow your safety net to grow even faster.  Left alone, you can average $120,000-$150,000 or more per year in extra income from a million dollar stock portfolio during bull markets.  In a given year, maybe reinvest $100,000 to buy more stocks and then put $50,000 into a new car or a home addition.

Everything beyond item 11 are luxuries.  These I place at the bottom of the list because they are less important.  Most  others (normal people) would place things like meals out and fancy clothes further up the list, probably before saving for future needs and debt avoidance.  A lot of families who are saving nothing for college or retirement go out to eat regularly. Retirement is number 7 on my list and eating out is number 13.  Note that I don’t have to have my entire retirement fund in place before I go out to eat or take a vacation – I just need to be saving enough from my paycheck to get there in time with some margin of safety.

Giving is number 12 on my list, and I’m sure that many people would say that this should be number 1 or 2.  They may be right, and I’ll admit I’m not as good a giver as I would like to be.  Still, I can’t see giving a lot to charities and others until I’ve taken care of necessities, gotten prepared for future needs, and set myself on a path to financial independence.  I would give a little all along, but I wouldn’t feel like I was in a position to really start giving significant amounts until I had taken care of items 1-11.

Note that I put buying the big home near the bottom, above only buying fancy clothing.  I also don’t have the expensive car on the list, but that might come somewhere near toys like iPods and ATVs.  The order of luxuries are really a personal choice.  And all budgets are personal.  If you want a big home and have done everything else, that’s your choice.  For me I don’t want the hassle.    I really could care less about wearing expensive clothes, so that would come last, maybe after I’d saved my first billion.  For you, you might want to live in a one bedroom apartment and wear designer clothes.  I knew one guy who stayed in a one-bedroom apartment for twenty years, but took all sorts of vacations to places I’d love to go.  Ordering your luxuries is your choice – just put them after necessities.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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